Tag Archives: Landry v. FDIC

SEC Declares All Is Okay Because Its ALJs Are Just Employees and Not “Inferior Officers”

On September 3, 2015, the SEC issued its first ruling addressing the constitutionality of its administrative law judges, in In the Matter of Raymond J. Lucia Cos., Inc., File No. 15006.  The opinion can be read here: SEC Opinion in In the Matter of Raymond J. Lucia Companies.  In substance, the SEC argued that its ALJs are “employees,” not “inferior officers” within the meaning of Article II of the Constitution.  In that respect, it disagreed with two federal courts that have addressed the merits of that issue, each of which found it “likely” that the ALJs are inferior officers, and therefore subject to Article II’s Appointments Clause.  See SDNY Court Ups the Ante, Allowing Duka Injunctive Action To Proceed on Appointments Clause Issue, and Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding.

The SEC now says “no,” arguing that its ALJs are sufficiently like the FDIC ALJ’s that were found not to be inferior officers in a split D.C. Circuit opinion in Landry v. FDIC, 204 F.3d 1125 (D.C. Cir. 2000).  That was an argument rejected by the two courts.  The SEC wrote:

Our consideration of this question is guided by the D.C. Circuit’s decision in Landry v. FDIC, which addressed whether ALJs should be deemed inferior officers or employees.  Landry held that, for purposes of the Appointments Clause, ALJs at the Federal Deposit Insurance Corporation (“FDIC”) who oversee administrative proceedings to remove bank executives are employees rather than inferior officers. Landry explained that the touchstone for determining whether adjudicators are inferior officers is the extent to which they have the power to issue “final decisions.”  Although ALJs at the FDIC take testimony, conduct trial-like hearings, rule on the admissibility of evidence, have the power to enforce compliance with discovery orders, and issue subpoenas, they “can never render the decision of the FDIC.”  Instead, they issue only “recommended decisions” which the FDIC Board of Directors reviews de novo, and “[f]inal decisions are issued only by the FDIC Board.”  The ALJs thus function as aides who assist the Board in its duties, not officers who exercise significant authority independent of the Board’s supervision.  Because ALJs at the FDIC “have no such powers” of “final decision,” the D.C. Circuit “conclude[d] that they are not inferior officers.”

The mix of duties and powers of the Commission’s ALJs are very similar to those of the ALJs at the FDIC. Like the FDIC’s ALJs, the Commission’s ALJs conduct hearings, take testimony, rule on admissibility of evidence, and issue subpoenas.  And like the FDIC’s ALJs, the Commission’s ALJs do not issue the final decisions that result from such proceedings. Just as the FDIC’s ALJs issue only “recommended decisions” that are not final, the Commission’s ALJs issue “initial decisions” that are likewise not final.  Respondents may petition us for review of an ALJ’s initial decision, and it is our “longstanding practice [to] grant[] virtually all petitions for review.”  Indeed, we are unaware of any cases which the Commission has not granted a timely petition for review.  Absent a petition, we may also choose to review a decision on our own initiative, a course we have followed on a number of occasions.  In either case, our rules expressly provide that “the initial decision [of an ALJ] shall not become final.”  Even where an aggrieved person fails to file a timely petition for review of an initial decision and we do not order review on our own initiative, our rules provide that “the Commission will issue an order that the decision has become final,” and it “becomes final” only “upon issuance of the order” by the Commission.  Under our rules, no initial decision becomes final simply “on the lapse of time” by operation of law; instead, it is “the Commission’s issuance of a finality order” that makes any such decision effective and final.  Moreover, as does the FDIC, the Commission reviews its ALJs’ decisions de novo.  Upon review, we “may affirm, reverse, modify, set aside or remand for further proceedings, in whole or in part,” any initial decision.  And “any procedural errors” made by an ALJ in conducting the hearing “are cured” by our “thorough, de novo review of the record.”  We may also “hear additional evidence” ourselves, and may “make any findings or conclusions that in [our] judgment are proper and on the basis of the record.”  For this reason, although ALJs may play a significant role in helping to shape the administrative record initially, it is the Commission that ultimately controls the record for review and decides what is in the record.  As we have explained before, we have “plenary authority over the course of [our] administrative proceedings and the rulings of [our] law judges—before and after the issuance of the initial decision and irrespective of whether any party has sought relief.”

Opinion at 30-31 (footnotes omitted).

The SEC rejected the argument, which the two courts found convincing, that the Supreme Court decision in Freytag v. Commissioner, 501 U.S. 868 (1991), supported the opposite conclusion, arguing that the “special trial judges” at issue in Freytag were more important than the SEC ALJs: “The far greater role and powers of the special trial judges relative to Commission ALJs, in our view, makes Freytag inapposite here.”  Opinion at 32.  The reasons for this view were:

First, unlike the ALJs whose decisions are reviewed de novo, the special trial judges made factual findings to which the Tax Court was required to defer, unless clearly erroneous.  Second, the special trial judges were authorized by statute to “render the [final] decisions of the Tax Court” in significant, fully-litigated proceedings involving declaratory judgments and amounts in controversy below $10,000.  As discussed above, our ALJs issue initial decisions that are not final unless the Commission takes some further action. Third, the Tax Court (and by extension the court’s special tax judges) exercised “a portion of the judicial power of the United States,” including the “authority to punish contempts by fine or imprisonment.”  Commission ALJs, by contrast, do not possess such authority.

Based on the foregoing, we conclude that the mix of duties and powers of our ALJs is similar in all material respects to the duties and role of the FDIC’s ALJs in Landry.  Accordingly, we follow Landry, and we conclude that our ALJs are not “inferior officers” under  the Appointments Clause.

Id. at 32-33 (footnotes omitted).

The reasoning is minimalist.  It ignores the decisions of the two federal courts.  It does not address the array of powers the SEC ALJs have that may differ from FDIC ALJs.  It does not explain why it believes that the differences it found between the “special trial judges” in Freytag and its own ALJs are of sufficient importance to warrant a different result.  And it does not discuss other Supreme Court decisions addressing when adjudicative officials should be considered to be “inferior officers.”  See Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit.

None of this is surprising.  There was zero chance the SEC was going to rule against its own appointments of ALJs.  That is one reason why decisions of several federal courts that the SEC should be given the chance to address the issue before the courts did, while perhaps lawyerly, seem so pointless.  But nothing about this opinion presents a compelling argument that the ALJs are mere employees, given the broad array of powers they have in determining how administrative cases are litigated and ultimately decided.  And, because the SEC essentially chooses to adopt the rationale of the majority in Landry v. FDIC rather than address the hard issues itself, it is unlikely that any appellate court outside of the D.C. Circuit, where Landry was decided, should, or would, be swayed by what the Commission had to say on the issue.

Straight Arrow

September 4, 2015

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Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding

In a breakthrough development, Northern District of Georgia federal district judge Leigh Martin May found that Charles Hill, a respondent in a pending SEC administrative proceeding, had a “substantial likelihood of success” of showing that the proceeding against him is unconstitutional because the appointment of the administrative law judge presiding over his case violated the appointments clause of Article II of the Constitution.  That is one of several arguments that have been made against the legality of the SEC’s administrative enforcement proceedings, and this is the first court to treat any of those arguments seriously.

Judge May’s decision is here: Order in Hill v. SEC.

 

Judge Leigh May. Photo by John Disney/Daily Report.

Judge Leigh May. Photo by John Disney/Daily Report.

The opinion, while tempered, is an eye-opener for the SEC, which has so far convinced other courts (and no doubt themselves) either not to consider these arguments or give them short shrift.  The Commission now has no choice but to reconsider whether its recent determination to shift important enforcement cases from federal courts to its administrative courts still makes sense.  One can assume there will be every effort to appeal this decision and get this decision overturned on an expedited basis, but that could take months, even in an accelerated proceeding, and the Eleventh Circuit might end up agreeing with Judge May.  The availability of a stay pending appeal may be in doubt because the order only halts the one proceeding against Mr. Hill, making the need for a stay questionable.  Alternatively, the Commission could expedite its own consideration of this issue in the pending Timbervest administrative proceeding (see SEC Broadens Constitutional Inquiry into Its Own Administrative Judges in Timbervest Case), rule in its own favor, and possibly get the issue to an appellate court with an added argument that the SEC’s decision is entitled to some deference.  Since Timbervest is located in Atlanta, that may also end up before the Eleventh Circuit.  In the meantime, there is a cloud over the entire SEC administrative enforcement process, although, as noted, Judge May’s order itself only halts the impending adminsitrative trial of Mr. Hill.

Judge May’s opinion was careful and thorough.  In the end, it came down to a single issue: whether the SEC’s administrative law judges are “executive officers” subject to the appointments clause and other Article II limits on diminishing executive power.  Some time ago, we wrote that this was a serious issue on which Supreme Court precedent seemed likely create problems for the SEC.  See Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit.  Until now, however, no court has been willing to give the argument thorough consideration.  See In Duka v. SEC, SDNY Judge Berman Finds SEC Administrative Law Enforcement Proceedings Constitutional in a Less than Compelling Opinion.

The opinion begins with a discussion of many of the respects in which “SEC administrative proceedings vary greatly from federal court actions.”  Slip op. at 4.  These include: the rules of evidence do not apply; respondents “are generally barred from taking depositions”; “SEC administrative proceedings also occur much more quickly than federal court actions”; “[c]ounterclaims are not permissible”; there is no equivalent of Rule 12(b) motions “to test the allegations sufficiency”; and “there is no right to a jury trial.” Id. at 4-5.

It then discusses the respective powers of the ALJ and the SEC: the presiding ALJ is selected by the chief ALJ, presides over the matter and issues an initial decision; the SEC may order interlocutory review of any ALJ decision during the proceeding; the initial decision can be appealed by either party or reviewed by the SEC on its own initiative; a decision is not final until the SEC issues it, but if there is no appeal and the SEC does not review an ALJ decision “it is deemed the action of the Commission,” and the SEC issues an order making that decision final; SEC review is de novo and new evidence can be heard, but “the SEC will accept the ALJ’s ‘credibility finding, absent overwhelming evidence to the contrary.’”  An SEC decision can be appealed to a federal court of appeals (either the D.C. Circuit or the Circuit where the respondent resides).  On appeal, the “SEC’s findings of facts are ‘conclusive’ ‘if supported by substantial evidence.’” Id. at 5-7.

The court then describes that SEC ALJs “are ‘not appointed by the President, the Courts, or the [SEC] Commissioners.  Instead, they are hired by the SEC’s Office of Administrative Law Judges, with input from the Chief Administrative Law Judge, human resource functions, and the Office of Personnel Management.’”  Id. at 7.  Congress authorized the SEC to delegate any of its functions to an ALJ, and the SEC promulgated regulations making ALJs responsible for the “fair and orderly conduct” of proceedings and giving them the authority to: “(1) Administer oaths and affirmations; (2) Issue subpoenas; (3) Rule on offers of proof; (4) Examine witnesses; (5) Regulate the course of a hearing; (6) Hold pre-hearing conferences; (7) Rule upon motions; and (8) Unless waived by the parties, prepare an initial decision containing the conclusions as to the factual and legal issues presented, and issue an appropriate order.”  Id. at 8.

The court then moved to the specifics of Mr. Hill’s prosecution, noting that he moved for summary disposition on constitutionality grounds but that ALJ James Grimes ruled that he lacked the authority to address two of the three grounds asserted: that “Congess’s delegation of authority to the SEC to pursue cases before ALJs violates the delegation doctrine in Article I of the Constitution,” and that “Congress violated his Seventh Amendment right to jury trial by allowing the SEC to pursue charges in an administrative proceeding.”  Id. at 10.  See SEC ALJ Says He Lacks Authority To Decide Key Constitutional Challenges.  Mr. Hill sought relief from the federal court to prevent the proceeding on these constitutionality grounds, and later amended his complaint to assert that the proceeding was also unconstitutional because “the SEC ALJ’s appointment violated the Appointments Clause of Article II as the ALJ is allegedly an inferior officer and he was not appointed by the President, the courts of law, or a department head.”  Slip op. at 10-11.

Turning to the legal determinations, Judge May first rejected the SEC’s contention that the court lacked jurisdiction to hear the case.  The SEC made this argument successfully in cases previously brought by other respondents, including Wing Chau and Laurie Bebo.  See SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding; Court Dismisses “Compelling and Meritorious” Bebo Constitutional Claims Solely on Jurisdictional Grounds.  The SEC argued “that its election to pursue claims against Plaintiff in an administrative proceeding, ‘channels review of Plaintiff’s claims through the Commission’s administrative process, with review in the courts of appeals,’” that is, “judicial review can only come from the courts of appeal following the administrative proceeding and the SEC’s issuance of a final order in Plaintiff’s case.”  Slip op. at 11-12.  The court found this “in tension with 28 U.S.C. § 1331, which provides that federal district courts ‘have original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States,’ and 28 U.S.C. § 2201, which authorizes declaratory judgments.”  Id. at 12.  The court rejected the SEC’s argument that “Congress declared its intent for the administrative proceeding to be the exclusive forum for judicial review for these cases by allowing the SEC to make the administrative proceeding its forum choice,” finding instead that “Congress’s purposeful language allowing both district court and administrative proceedings shows a different intent.  Instead, the clear language of the statute provides a choice of forum, and there is no language indicating that the administrative proceeding was to be an exclusive forum.”  Id. at 13.

Moving beyond this point to the issue addressed previously by two other courts in the SEC’s favor – whether Supreme Court precedent on the issue supports a finding that Congress did withdraw jurisdiction – Judge May found otherwise because:

(1) “If Plaintiff is required to raise his constitutional law claims following the administrative proceeding, he will be forced to endure what he contends is an unconstitutional process.”  Slip op. at 15.  Critically, Mr. Hill “does not challenge the SEC’s conduct in that proceeding or the allegations against him—he challenges the proceeding itself” (id. at 17).  “Waiting until the harm Plaintiff alleges cannot be remedied is not meaningful judicial review.”  Id. at 18.

(2) The constitutional challenge is “wholly collateral” to the merits of the proceeding itself.  “Plaintiff is not challenging an agency decision; Plaintiff is challenging whether the SEC’s ability to make that decision was constitutional.  What occurs at the administrative proceeding and the SEC’s conduct there is irrelevant to this proceeding which seeks to invalidate the entire statutory scheme.”  Id. at 20.

(3) The constitutional issues are outside the SEC’s expertise.  “Plaintiff’s constitutional claims are governed by Supreme Court jurisprudence, and ‘the statutory questions involved do not require technical considerations of agency policy.’”  Id. at 21.

This aspect of the opinion is consistent with Judge Richard Berman’s decision in Duka v. SEC (SDNY).  Judge Berman, however, went on to reject Ms. Duka’s constitutional argument, finding the she was “unlikely to succeed on the merits” of that claim.

Having likewise found her court had jurisdiction over Mr. Hill’s claim, however, Judge May went in a different direction on the merits of the preliminary injunction sought by Mr. Hill.  The critical issue was whether Mr. Hill had “a substantial likelihood to succeed on the merits” on his constitutional claims.

Judge May found no such likelihood of success for the argument that the power given to the SEC in the Dodd-Frank Act to bring these cases in its administrative court was an unconstitutional delegation of legislative power.  Instead, she found this authority was a form of prosecutorial discretion that is an executive power, not a delegated legislative power.  “When the SEC makes its forum selection decision, it is acting under executive authority and exercising prosecutorial discretion. . . .  Because Congress has properly delegated power to the executive branch to make the forum choice for the underlying SEC enforcement action, the Court finds that the Plaintiff cannot prove a substantial likelihood of success on the merits on his non-delegation claim.”  Slip op. at 23-29.

On the Seventh Amendment jury trial issue, the court likewise found no substantial likelihood of success.  Judge May found Supreme Court precedent on this controlling because SEC prosecutions involve “public rights,” since the SEC “is acting as a sovereign in the performance of its executive duties when it pursues an enforcement action.”  The controlling Supreme Court case, Atlas Roofing Co. v. Occupational Safety & Health Review Comm’n, 430 U.S. 442 (1977), rejected the jury trial argument in administrative enforcement actions brought by OSHA.

One might question whether this addresses the true jury trial issue in SEC cases.  Unlike the OSHA case, the SEC traditionally prosecuted alleged violations of the securities laws by unregulated persons in federal court actions, in which there is a jury trial right as to non-equitable claims.  Only after Dodd-Frank was enacted was the SEC permitted to commence the same actions in its administrative courts.  That means the SEC was given the power to deny a defendant what for many years has been a jury trial right, and, because there are no standards governing how to go about doing this, currently does so without any enforceable or predictable guidelines for the decision.  That raises a combination of jury trial, equal protection, and arbitrary and capriciousness arguments that the Atlas Roofing case does not begin to address.  I expect a more definitive consideration of the jury trial issue is yet to come.   

Judge May did ultimately find a substantial likelihood of success on one of Mr. Hill’s constitutional arguments, which raises the question of whether it was prudent to decide these first two constitutional issues when they did not, in the end, have a bearing on her decision.  Normally, a court strives to avoid constitutional issues if possible.

But the blockbuster part of the opinion is certainly the discussion of the alleged Article II violations.  Judge May did find a substantial likelihood of success on at least one of Mr. Hill’s alleged violations of Article II – whether the appointment of ALJ Grimes violated the appointments clause in Article II, section 2, clause 2.  (Having reached that conclusion, she found it unnecessary to decide the other Article II issue – whether the double layer of tenure protection for SEC ALJs unacceptably encroached on the President’s executive power.  Why was that given different treatment than the delegation and jury trial issues?)

The threshold question for each of these arguments was whether SEC ALJs are “executive officers” within the meaning of Article II.  We previously discussed this issue at length (in the aforementioned Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit), and expressed the view that Supreme Court precedent in Freytag v. Commissioner, 501 U.S. 868 (1991), strongly suggested that the SEC ALJs were, indeed, “inferior officers” within the meaning of Article II.  Judge May agreed that Freytag was effectively controlling, as follows:

The issue of whether the SEC ALJ is an inferior officer or employee for purposes of the Appointments Clause depends on the authority he has in conducting administrative proceedings. . . .  The Appointments Clause . . . creates two classes of officers: principal officers, who are selected by the President with the advice and consent of the Senate, and inferior officers, whom “Congress may allow to be appointed by the President alone, by the heads of departments, or by the Judiciary.” . . .  The Appointments Clause applies to all agency officers including those whose functions are “predominately quasi judicial and quasi legislative” and regardless of whether the agency officers are “independent of the Executive in their day-to-day operations.” . . .

“[A]ny appointee exercising significant authority pursuant to the laws of the United States is an ‘Officer of the United States,’ and must, therefore, be appointed in the manner prescribed by § 2, cl. 2, of [Article II].” . . .  By way of example, the Supreme “Court has held that district-court clerks, thousands of clerks within the Treasury and Interior Departments, an assistant surgeon, a cadet-engineer, election monitors, federal marshals, military judges, Article I [Tax Court special trial] judges, and the general counsel for the Transportation Department are inferior officers.” . . .

Plaintiff claims that SEC ALJs are inferior officers because they exercise “significant authority pursuant to the laws of the Unites States” while the SEC contends ALJs are “mere employees” based upon Congress’s treatment of them and the fact that they cannot issue final orders and do not have contempt power. . . .  The Court finds that based upon the Supreme Court’s holding in Freytag, SEC ALJs are inferior officers.

 In Freytag, the Supreme Court was asked to decide whether special trial judges (“STJ”) in the Tax Court were inferior officers under Article II. . . .  The Government argued, much as the SEC does here, that STJs do “no more than assist the Tax Court judge in taking the evidence and preparing the proposed findings and opinion,” id., and they “lack authority to enter a final decision.” . . .  The Supreme Court rejected that argument. . . .

The Court finds that like the STJs in Freytag, SEC ALJs exercise “significant authority.” The office of an SEC ALJ is established by law, and the “duties, salary, and means of appointment for that office are specified by statute.” . . .  ALJs are permanent employees—unlike special masters—and they take testimony, conduct trial, rule on the admissibility of evidence, and can issue sanctions, up to and including excluding people (including attorneys) from hearings and entering default. . . .

Slip op. at 35-38 (citations omitted).

Judge May went on to consider the divided decision of a D.C. Circuit panel in Landry v. Federal Deposit Insurance Corp., 204 F.3d 1125 (D.C. Cir. 2000), that ALJs at the FDIC were not executive officers.  She was convinced that the concurring minority opinion in that case was more true to Freytag than the majority of the panel, and, like the concurring judge in Landry, concluded “that the Supreme Court in Freytag found that the STJs powers—which are nearly identical to the SEC ALJs here—were independently sufficient to find that STJs were inferior officers.”  Slip op. at 40.

Judge May also rejected the SEC’s argument that the court “should defer to Congress’s apparent determination that ALJs are inferior officers” because “Congress is presumed to know about the Appointments Clause, and it decided to have ALJs appointed through OPM and subject to the civil service system,” and therefore “intended for ALJs to be employees.”  Id. at 41.  Because the appointments clause “prevents Congress from dispensing power too freely,” Judge May found that argument unacceptable: “Congress may not ‘decide’ an ALJ is an employee, but then give him the powers of an inferior officer; that would defeat the separation-of-powers protections the Clause was enacted to protect.”  Accordingly, the court found “that SEC ALJs are inferior officers.”  Id.  Moreover, because the SEC “concedes that Plaintiff’s ALJ, James E. Grimes, was not appointed by an SEC Commissioner,” he “was not appointed by the President, a department head, or the Judiciary” as the appointments clause requires.”  As a result, “[b]ecause he was not appropriately appointed pursuant to Article II, his appointment is likely unconstitutional in violation of the Appointments Clause.”  Id. at 42.

We might add that by all appearances ALJ Grimes’s treatment of the constitutional challenges to the proceeding before him has been handled responsibly, even to the point of granting a subpoena on the SEC sought by Mr. Hill relating to a due process challenge on the basis of possible systemic bias in the administrative court.  See SEC ALJ James Grimes Issues Important Discovery Order Against SEC.

Judge May went on to find the other requirements for a preliminary injunction satisfied (id. at 42-43), and ruled that “a preliminary injunction is appropriate to enjoin the SEC administrative proceeding and to allow the Court sufficient time to consider this matter on the merits.”  Id. at 44.

The judge’s final words addressed whether all of this was important enough to support potentially debilitating relief (and least in the short term):

The Court notes that this conclusion may seem unduly technical, as the ALJ’s appointment could easily be cured by having the SEC Commissioners issue an appointment or preside over the matter themselves.  However, the Supreme Court has stressed that the Appointments Clause guards Congressional encroachment on the Executive and “preserves the Constitution’s structural integrity by preventing the diffusion of appointment power.” Freytag, 501 U.S. at 878.  This issue is “neither frivolous or disingenuous.” Id. at 879. The Article II Appointments Clause is contained in the text of the Constitution and is an important part of the Constitution’s separation of powers framework.

In addition, the Appointments Clause may not be waived, not even by the Executive.  Id. at 880 (“Neither Congress nor the Executive can agree to waive this structural protection.”).  As this likely Appointment Clause violation “goes to the validity of the [administrative] proceeding that is the basis for this litigation,” id. at 879, it is hereby ORDERED that Defendant, the Securities and Exchange Commission, is preliminarily enjoined from conducting the administrative proceeding brought against Plaintiff . . . including the hearing scheduled for June 15, 2015, before an Administrative Law Judge who has not been appointed by the head of the Department.

Slip op. at 44.

The SEC is likely unprepared for this occurrence.  But, as we previously wrote, the case law strongly supported the view that SEC ALJs are, indeed, inferior executive officers, and serious constitutional issues flow from that, including the appointments clause issue now decided against the SEC.

As the court notes, there may be some tweaks that could clear up this issue, although they may well require action by Congress amending the statutory provisions governing the appointment of administrative law judges (an issue I’ve not looked at).  But even if a “cure” is possible with such tweaks, they would not address the more fundamental question of whether the SEC is doing the right thing by bringing serious prosecutorial actions like these against persons not subject to SEC regulatory oversight in the administrative court.  The lengthy list given by Judge May of the respects in which respondents are impeded from presenting a defense in the administrative forum, as compared to federal courts, should give a fair-minded Commission pause about whether its recent policy of increased administrative enforcement actions needs to be reconsidered.  See Former SEC Enforcement Leaders Urge SEC To Reform Administrative Enforcement Process.  The bottom line is that when unregulated persons are prosecuted for alleged violations and face debilitating demands for penalties and purported “disgorgement,” plus the usual SEC effort to bar these people from future employment as officers or directors of public companies, perhaps the “right” thing to do is allow them to defend themselves in a forum that provides a more level playing field.  Is it really that hard to “do the right thing”?

Straight Arrow

June 9, 2015

Contact Straight Arrow privately here, or leave a public comment below:

Briefing of ALJ Constitutionality Before SEC Leaves Resolution in Doubt

We discuss today the SEC’s pending consideration of a challenge to its administrative law process in In the Matter of Timbervest, LLC et al., File No. 3-15519.

Briefly, the case involved alleged violations of sections 206(1) and 206(2) of the Investment Advisors Act.  Timbervest is an Atlanta company that manages timber-related investments. The SEC alleged that in 2006 and 2007, company officers received unauthorized and undisclosed real estate commissions paid out of the pension plan assets of Timbervest’s largest client.  The SEC further alleges that in 2005-2006, Timbervest made an undisclosed and unauthorized sale of a timberland property from a fund holding that same client’s pension assets to another investment fund the firm managed.

The order instituting proceedings was issued in September 2013.  The administrative proceeding was tried before SEC Administrative Law Judge Cameron Elliot, who issued his Initial Decision in August 2014.  Mr. Elliot found for the Division of Enforcement in all respects except that he concluded two of the individual respondents lacked the scienter required for aiding and abetting the firm’s violations, and that the five-year statute of limitations in 28 U.S.C. § 2462 precluded the associational bars sought against the individuals and the revocation of Timbervest’s adviser’s license.  Both the respondents and the Division of Enforcement petitioned the SEC for review, and both petitions were granted.  In their ensuing filings, the respondents argued, among other things, that the administrative process was unconstitutional because SEC ALJs are executive officers who enjoy “two-tiered tenure protection,” although they dedicated only two paragraphs in their opening brief to this issue, and the Division of Enforcement responded with only one paragraph in its opposition brief.  In response, the Commission asked that the parties file supplemental briefs on that issue.

Those supplemental briefs have now been filed.  The Division of Enforcement’s supplemental brief is here, the respondents’ supplemental brief is here, and a supplemental notice of authority by the respondents is here.  The SEC recently scheduled oral argument on the case for June 8, 2015.  We know, of course, that the SEC is going to uphold the constitutionality of its own ALJs, so the result at this stage is not really in question.  But there will be an appeal to a court of appeals (either the D.C. Circuit or the Eleventh Circuit are possibilities), so it’s useful to see how convincingly the Division of Enforcement argued the constitutionality issue to the Commission.  By my measure, the arguments made are pretty weak, which still leaves to $64,000 Question: will a court of appeals or the Supreme Court really be willing to invalidate the SEC ALJ framework on the basis of this record?

The Division of Enforcement argued that “Commission administrative proceedings do not violate Article II of the Constitution” because “Commission ALJs are not constitutional officers – the only Court of Appeals to have considered the status of an agencys ALJs concluded they are employees, see Landry v. FDIC, 204 F.3d 1125, 1132-34 (D.C. Cir. 2002) – and therefore the removal framework applicable to them does not implicate Article II. And even if Commission ALJs were constitutional officers, the President exercises adequate control to satisfy the Constitution.”  Division Supplemental Br. at 1.

Let’s examine those arguments.

The Argument that “Commission ALJs Are Not Constitutional Officers”

The first argument – that the SEC ALJs are “employees” rather than “inferior officers” from a constitutional standpoint – seems particularly weak.  Perhaps if the SEC were writing on a blank slate this might be sustainable.  But it is not deciding this issue without controlling guidance.  There are a number of Supreme Court decisions out there that must be taken into account.  The Division’s brief does a poor job of addressing these binding precedents.

As we previously wrote (see Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit), the Supreme Court addressed similar issues in decisions in Freytag v. Commissioner, 501 U.S. 868 (1991), Weiss v. United States, 510 U.S. 163 (1994); Ryder v. United States, 515 U.S. 177 (1995); and Edmond v. United States, 520 U.S. 651 (1997).  Freytag ruled that special trial judges for the Tax Court were “inferior Officers” under the constitution, and not “employees” who assisted Tax Court judges in taking evidence and preparing a ruling – even though they lacked authority to render “final decisions” – because they exercised significant discretion in performing tasks like taking testimony, conducting trials, ruling on the admissibility of evidence, and deciding and ordering compliance with discovery orders.  Weiss noted that military judges were Officers of the United States because of their authority and responsibilities, but the issue was not contested by the parties.  Ryder ruled that that judges serving on the Coast Guard Court of Military Review were officers covered by the Appointments Clause, even though they were subject to review by a higher appellate court.  And Edmond explained that intermediate appellate military judges were not “principal officers,” because they were subordinate to a higher ranking officer below the President, were subject to oversight, and could not render final decisions, but plainly considered them to be “inferior officers.”

These cases negate many of the arguments made in the Division’s brief.  It mattered not that these other officials found to be executive officers were involved in a preliminary process; could not render final decisions; were subject to being reversed; served in an adjudicatory, rather than a “core executive” capacity; were subject to supervision by others; and even were “subordinate” to others.  All of the Division’s arguments that ALJs are “employees,” and not “executive officers” for those reasons simply cannot survive contrary Supreme Court precedent.

The invocation of the D.C. Circuit decision in Landry v. FDIC cannot change this.  In Landry, a split D.C. Circuit panel ruled that an FDIC ALJ was not an “inferior officer,” but was instead a mere “employee.”   The opinion questioned the usefulness of the Supreme Court’s guidance in Buckley v. Valeo, 424 U.S. 1, 126 n.162 (1976), that “any appointee exercising significant authority pursuant to the laws of the United States is an ‘Officer of the United States.’”  But the Buckley language was the starting point for the analysis of this issue in Freytag, in which the Court found dispositive the “significance of the duties and discretion that special trial judges possess.”  501 U.S. at 881.  The Landry majority argued that the critical difference between the special trial judges in the Tax Court and the FDIC ALJs was that FDIC ALJs only made “recommendations” to the FDIC, and thus could never issue final decisions.  Not only did that misread Freytag, which focused on the array of “significant” “duties and discretion” of the special trial judges, and not final decision-making powers, but it also ignored the discussions in Weiss, Ryder, and Edmonds, which made it plain that being a final decision-maker was not a decisive factor in determining whether someone is an “inferior officer.”

But even accepting the Landry majority opinion on its face, it provides little assistance to the Division because in some cases SEC ALJs do make “final decisions” like the special trial judges of the Tax Court.  The FDIC was required to review every ALJ “recommendation.”  But the SEC can, and does, decline to review ALJ decisions, and in those cases, it matters little to constitutional analysis that these decisions require a ministerial Commission order to make them formally “final” and appealable.  Moreover, the SEC does not, and cannot realistically, review an ALJ’s management and oversight of the administrative trial itself, during which many “final decisions” are made on important issues that determine the record the SEC can review.  And, of course, the approach taken by a court of appeals panel – and a split one at that – hardly trumps the guidance of the Supreme Court on how to go about determining whether a government official is an “inferior officer.”

The final nail in the coffin of the Division’s argument that the D.C. Circuit decided once and for all in Landry that ALJs are only agency “employees,” and not executive “officers,” is laid out in the Timbervest respondents’ brief.  They point out that the Government itself admitted this is not so.  To avoid a writ of certiorari in Landry, the Government represented to the Supreme Court that the Landry court did not decide that issue.  Here is what the Solicitor General said: “The court of appeals did not purport to establish any categorical rule that administrative law judges are employees rather than ‘inferior Officers.’ . . .” Timbervest Respondents’ Br. at 16 (quoting the U.S. Government brief in opposition to the petition for writ of certiorari).

The Division’s brief presents another argument that carries little water on the “inferior officer” versus “employee” issue: that Congress already decided that ALJs are just employees, not executive officers, by its “placement of the position within the competitive service system,” and the courts must defer to that decision by Congress.  That is wrong in two respects.  First, there is no indication that Congress made any such decision when it placed ALJs within the overall civil service system, and the Division cites no support for that contention.  Second, and far more importantly, it should be wrong that Congress has the power to decide when double-tenure protection can prevent the President from influencing government officials simply by designating those officials to be mere “employees.”  The whole point of the separation of powers doctrine is to assure that Congress may not deprive the President of his constitutional authority to execute the laws; it would be bizarre if Congress could grant executive powers to officials and then insulate them from the President’s influence by exercising Legislative muscle.  The best the Division could muster on this point was language in Justice Souter’s concurring opinion in Weiss suggesting “deference to the principal branches’ judgment is appropriate” (Divison Br. at 8, quoting 510 U.S. at 194), but that is a slim reed that cannot, I believe, be sustained without doing serious harm to the separation of powers concept.

Freytag and the other Supreme Court cases make it crystal clear that whether an executive official is an “inferior officer” depends on the “significance of the duties and discretion” that the official possesses, not a Congressional designation.  The Division simply cannot avoid the obvious similarity – and near congruence – of the “duties and discretion” of SEC ALJs in comparison to the special trial judges at issue in Freytag.  The Court, which was otherwise divided, unanimously viewed the special trial judges as “inferior officers” within the meaning of the Constitution based on their duties, discretion, and overall role in executive department proceedings, which showed that they exercised “significant authority pursuant to the laws of the United States.”  The SEC ALJs have, in reality, at least as great, and almost surely greater, authority and discretion in SEC administrative law enforcement proceedings, and no argument made by the Division in its brief shows otherwise.

The Argument that “Even if Commission ALJs Were Constitutional Officers, the President Exercises Adequate Control To Satisfy the Constitution”

The Division’s argument that the President has adequate control over SEC ALJs faces only one major obstacle: the Supreme Court’s decision in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010).  There, the Court found that a double layer of “for cause” protection for executive officers from removal by the President was constitutionally unacceptable.  The Division’s task is to identify differences that justify allowing double “for cause” protection for SEC ALJs despite the Free Enterprise Fund decision.  The Division is assisted here by footnote 10 of the opinion, which said: “our holding does not address that subset of independent agency employees who serve as administrative law judges. . . .   And unlike members of the Board, many administrative law judges of course perform adjudicative rather than enforcement or policymaking functions.”  561 U.S. at 507 n.10.

As we saw above, the mere fact that the SEC ALJs “perform adjudicative . . . functions” is not enough under Supreme Court precedent to prevent them from being executive officers performing executive functions.  And on this front, it does not help the Division that the SEC ALJs plainly serve as key players in the SEC’s law enforcement function.

The Division makes the argument, correctly, that the separation of powers doctrine does not create a rigid, formal structure of Branches hermetically-sealed from one another.  The Supreme Court recognizes that there are gray areas, and in such cases it is appropriate to conduct a functional analysis of the extent to which a statutory framework truly impairs a Branch from performing its constitutional duties.  Perhaps the best example of that is the special prosecutor case, Morrison v. Olson, 487 U.S. 654 (1988), which adopted a multifactor test to determine whether the statute that limited Executive control over the special prosecutor was consistent with the separation of powers doctrine.  The Division appropriately quotes Morrison’s statement that interference with removal of the special prosecutor can be acceptable if it does not “interfere with the President’s exercise of the ‘executive power’” or the duty to “take care that the laws be faithfully executed.”  Division Br. at 14 (quoting 487 U.S. at 689-90).

The Division’s brief goes on to draw distinctions between the PCAOB and the SEC’s administrative law judges, mostly by focusing on the PCAOB’s broader role in policymaking, as well as arguing that the PCAOB exercises power more independently than the ALJs.  Whether these are distinctions of constitutional dimension is not apparent, however, since in the realm in which the ALJs function, they have a high degree of independent control over a key law enforcement function, and the constitutional importance of whether they do or do not make policy (as opposed to performing other executive functions) is by no means clear.  But the point is sufficiently made that the analogy between the PCAOB and the ALJs is not so close that it is, in and of itself, compelling (as compared to the analogy of ALJs to the special trial judges in Freytag, which is so close that it is compelling).

Having made a credible showing that the unconstitutionality of the SEC ALJs does not follow inexorably from the Free Enterprise Fund decision, the Division turned to the argument that double insulation of the ALJs from Presidential removal does not significantly impair the President’s executive powers.  The Division makes five arguments.  Four of them are less than compelling; one is downright embarrassing.

First, the Division argues that the Commission decides when the ALJs get to decide cases, and the Commission has only one layer of “for cause” removal protection.  That formalistic argument would seem to carry little weight as part of a functional analysis, however.  From a realistic, functional standpoint, the Commission does – and in reality must – utilize the ALJs to do its enforcement work because it could not handle the workload without them. Put another way, the creation of the ALJs allows the Commission to expand its enforcement activity exponentially, and fueling that expansion with executive officers who cannot be influenced by the President has a real, functional effect on the President’s ability to execute the laws.

Second, the Division argues that “the functions that the Commission has assigned to its ALJs are limited in scope and do not rise to the level of core executive authority.”  Division Br. at 18.  This argument is, in essence, that because ALJs only adjudicate cases, and do not “make policy,” their activities do not significantly impair the President’s execution of the laws.  As the Division says: SEC ALJ adjudications “involve the application of the law to a discrete set of facts in individual cases.”  Id.  I see two problems with this argument. One, it runs headlong into the Supreme Court decisions (discussed above) that either hold, or assume, that officials performing adjudicative roles within an executive function are important facets of the President’s duty to oversee the faithful execution of the laws.  Two, overseeing individual prosecutions, finding facts in those cases, weighing the importance and implications of those facts under the law, and determining whether there are violations, and what remedies should be imposed if there are, are arguably the essence of “core executive authority” because law enforcement prosecutions are a core executive function.

Third, the Division argues that the President can “exercise constitutionally adequate control” over ALJ decisions because “the Commission retains ultimate authority over administrative proceedings” and “exercises sufficient control over SEC ALJs regardless of the limittations placed upon their removal.”  Division Br. at 19.  This is essentially a rehash of earlier points, and runs into the reality, and the buzzsaw of prior Supreme Court decisions, that adjudicators do, in fact, make essentially non-reviewable discretionary decisions that control how a case is presented to the Commission.  They mold the record the Commission gets to review, and that power substantially impacts – or certainly can substantially impact – the Commission’s substantive review powers.

Fourth, the Division argues that the double-tenure protection accorded to SEC ALJs is less extreme than the protection provided to the PCAOB members.  Id.  This is largely a one-paragraph throw-away point, as the Division makes no effort to explain how the difference it argues has a functional impact on Presidential control.

Fifth, “the Executive Branch’s use of tenure-protected ALJs for nearly seventy years establishes a gloss on the Constitution that supports the current removal framework.” Division Br. at 20.  The Division would have been better off leaving this out.  The SEC cannot seriously find that the structure of its administrative enforcement process should be deemed constitutional simply because it has been around for a long time.  The argument is revealing, however, because it reflects what the SEC staff – and probably the SEC itself – really thinks.  They could have written the point more eloquently if they said what they meant (paraphrasing the famous line in Treasure of the Sierra Madre): “Constitutional authority?  We don’t need no stinking constitutional authority.”

[The actual line in the movie is: “Badges?  We ain’t got no badges.  We don’t need no badges.  I don’t have to show you any stinkin’ badges!”  And, as a diversion, enjoy this clip, this one from Blazing Saddles, and this montage.]

Humphrey Bogart in Treasure of the Sierra Madre

Humphrey Bogart in Treasure of the Sierra Madre

Alfonso Bedoya as

Alfonso Bedoya as “Gold Hat” in Treasure of the Sierra Madre — He don’t need no stinkin’ badges.

Seriously, though, the Division’s discussion of why the double-tenure protection of ALJs does not significantly impair the President’s ability to control SEC administrative law enforcement decisions is light on focused analysis of the nature of those law enforcement decisions, the respects in which the Chief Executive may have an interest in influencing those decisions, and the ways in which he can achieve those goals notwithstanding the double-tenure protection.  That is the kind of functional analysis called for by Morrison v. Olson, and the Division brief fails to address those key issues.

Based on reviewing these briefs, this continues to be a close call. The hydraulics are in the Division’s favor – certainly before the Commission, but also before an ultimate court of appeals, which will stretch mightily to avoid undercutting the SEC ALJ framework, and presumably other similar independent agency administrative enforcement frameworks (executive agencies, however, would not present the double-tenure protection issue).

Straight Arrow

May 6, 2015

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Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit

It’s not often that securities litigators get to breathe the rarefied air of constitutional law, but there are some challenging constitutional issues now being raised in opposition to the SEC’s use of administrative proceedings for its civil enforcement proceedings.

A range of such issues could be raised, some of them not limited to the administrative proceedings themselves.  They derive from the SEC’s peculiar (at least constitutionally) combination of authorities, powers, and responsibilities under the statutory framework created in the Securities Exchange Act of 1934.

In particular, the constitutionality of the administrative proceedings presided over by SEC administrative law judges has been challenged in two recent district court filings in Peixoto v. SEC and Stilwell v. SEC.  Those cases argue the administrative law judges cannot properly preside over such proceedings because they are officers of the United States who are not subject to removal at will by either the President or an appointee of the President, in violation of Article II of the Constitution.  Se our earlier discussion of these allegations here.  The complaints filed in those cases can be found here (Peixoto v SEC) and here (Stilwell v SEC).  Issues of due process were raised in Wing  Wing Chau v. SEC).  And there remains a distant cloud over much of the prosecutorial power of the SEC itself because its commissioners do not answer to the President when they exercise such powers.

A Little History Will Get Us Started

Although the first so-called independent agency was created before the turn of the 20th century when the Interstate Commerce Commission was established, the enormous growth of the so-called “Fourth Branch” came in the 1930s, when the Roosevelt Administration undertook a fundamental restructuring of the national government, based on a growing legal movement arguing that government affairs had grown too complex and specialized to be run by the purely political executive branch.  Complex commercial and financial activities, it was said, require the oversight of specialists in the field, who can apply expertise that normal executive department appointees, who come and go, cannot develop.  Brilliant legal minds like Felix Frankfurter developed jurisprudential theories justifying the need for, and propriety of, these administrative entities under our legal traditions.  Generations of lawyers have since been trained to accept this model as an enlightened approach to governance of the complex industrial state.

Frankfurter was a progenitor of the administrative state.  He was certain that the only viable means of governing a complex modern industrial state was to create government bureaus composed of experts who could apply neutral, scientific principles to guide commerce in the right direction.  He wrote in 1932:

Governmental regulation of banking, insurance, public utilities, industry, finance, immigration, the professions, health and morals, in short, the inevitable response of government to the needs of modern society, is building up a body of enactments not written by legislatures and of adjudications not made by courts, and only to a limited degree subject to their revisions.  These powers are lodged in vast congeries of agencies.  We are in the midst of a process, still largely unconscious and unscientific, of adjusting the play of these powers to the traditional system of Anglo-American law and courts.

Frankfurter and Davison, Cases and Other Materials on Administrative Law (1932), at vii.

So began the modern administrative state.  Multiple administrative agencies were created to develop rules governing commercial and financial activities, and to oversee compliance with those rules.  The FTC was created in 1914 to promote competition amidst great concern about trusts and monopolies, but it also was involved in efforts to try to deal with sharp practices in the sale of securities.  A focus on securities practices during the 1932 campaign led to the early proposal of a securities act, which became the Securities Act of 1933.  For a year, it was the FTC that had responsibility for overseeing that statute.  In 1934, the SEC was created in the Securities Exchange Act of 1934.  (Interestingly, some questioned the constitutionality of giving an independent agency the powers granted to the SEC, suggesting instead in earlier legislative proposals that they be given to the U.S. Post Office, based on the notion that the use of the postal service was key to securities transactions.)  Felix Frankfurter, who was thought by Roosevelt to be perhaps the greatest legal mind of his time, was a key architect of that statute.

Frankfurter brought with him some key protégés, not the least of which was James Landis, who eventually served on the FTC and as Chairman of the SEC from 1935 to 1937.  Landis is most renowned for his encomium to administrative agencies in the book The Administrative Process (1938).  In that book, Landis argued that the Nation desperately needed a “Fourth Branch” because of “the inadequacy of a simple tripartite form of government to deal with modern problems.”  Like Frankfurter, he believed that because complexities of modern commerce, “the need for expertness became dominant.”  In his view, legislation should only identify the scope of subject matter for an agency and the issues it should address, and then stand aside and allow administrative experts to apply broad discretion to those matters.  Landis and another Frankfurter acolyte, Benjamin Cohen, created the first draft of the Securities Act of 1933.

Felix Frankfurter

Frankfurter signature

James Landis 1936Benjamin V. Cohen

                James Landis                                                                                Benjamin Cohen

Even as the governmental alphabet soup burgeoned with the establishment of the SEC, FCC and other agencies, it was apparent that the precise constitutional nature of these entities was not clear.  They were touted as the best means of regulating business activity because they were supposedly “non-political,” applying expertise to set an enlightened path to guide and develop commerce.  To promote that theoretical aim, and because they were to set rules for and govern vast portions of United States commerce, these agencies were designed not to be a captive of, or to answer to, the “political” branches – the President and the Congress.

The SEC itself was created in the Securities Exchange Act of 1934.  There was a legislative battle over whether the securities regulator would be the FTC or a new commission created specifically to oversee the securities exchanges.  Roosevelt preferred FTC oversight, but a separate SEC won the day largely because of fear that the FTC would overregulate the securities industry.  Like the FTC, the SEC was conceived as an “independent agency,” with five commissioners that were Presidential appointees subject to Senate approval.  A maximum of three commissioners could be members of the same party.  It was intended by its creators to populate the growing “Fourth Branch.”

Like the FTC, and unlike an executive department, the President was not given the power to remove a commissioner.  In fact, although the Federal Trade Commission Act gave the President power to remove FTC commissioners for “inefficiency, neglect of duty, or malfeasance in office” (i.e., not “at will”), the Securities Exchange Act had no provision addressing removal of commissioners.  It has since remained unclear what power the President may have to remove SEC commissioners, although it is usually assumed that he may do so only “for cause,” i.e., like the FTC, for “inefficiency, neglect of duty, or malfeasance in office.”  The only time the Supreme Court addressed that issue, it accepted a stipulation by the parties that SEC commissioners “cannot themselves be removed by the President except [for] “inefficiency, neglect of duty, or malfeasance in office,” and “decide[d] the case with that understanding.”  Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477, 487 (2010) (“Free Enterprise Fund”).

The Problem

The constitutional problems created by some powers and authorities exercised by the SEC arise out of the Commission’s intended independence of the Executive Branch.  As discussed above, there is no doubt that independence was intended.  The ability to act independently of both the Executive and Legislative Branches was the sine qua non of Frankfurter and his disciples because that was the only way to create the hypothesized “experts” that would provide reasoned, non-political, direction to the Nation’s complex financial and commercial activity.  James Landis’s The Administrative Process left no doubt that the intention of the creators of “independent agencies” was indeed to make them independent of the branches of government designated in the Constitution.  Here are his words:

The reasons for favoring [the independent, regulatory administrative agency] seem simple enough – a desire to have the fashioning of industrial policy removed to a degree from political influence.  At the same time, there seems to have been a hope that the independent agency would make for more professionalism than that which characterized the normal executive department.  Policies would thus be more permanent and could be fashioned with greater foresight than might attend their shaping under conditions where the dominance of executive power was pronounced.  Again, the idea of the independent Commission seems naturally to have evolved from the very concept of administrative power.  That power embraces functions exercisable by all three branches of government.  To have taken these functions and to have placed them in the hands of any one of the three branches of government would have seemed incongruous.  The natural solution was to place them beyond the immediate control of any one of the three branches, yet subject to checks by each of them.

Landis, The Administrative Process (1966 ed.), at 111.  Landis goes on to note that independence allowed agencies “to have achieved a degree of permanence and consistency that they might not have possessed had their formulation been too closely identified with the varying tempers of changing administrations,” and “professionalism in the nonindependent agencies has suffered on occasion at the hands of political superiors.”  Id. at 113-14.

But the traditional “separation of powers” among the three branches of government recognized in Articles I-III of the Constitution – Legislative, Executive, and Judicial – could not easily accommodate this new conception; recall that Landis argued the administrative agencies were needed to cure “the inadequacy of a simple tripartite form of government to deal with modern problems.”  Id. at 1.  Ever since 1935, the Supreme Court has had great difficulty articulating how to accommodate the Constitution’s framework with various forms of creative governing mechanisms that fall outside of Articles I, II or III.

In a nutshell, the SEC’s constitutional challenges are: (1) to remain consistent with Article II’s statement of Executive powers and responsibilities while pursuing law enforcement activities that by all appearances are Executive functions, i.e., “executing” those laws placed by Congress within its (and not the Executive’s) jurisdiction; and (2) to adjudicate law enforcement proceedings internally while still complying with judicial concepts of due process and fundamental fairness.

The constitutional quagmires that the SEC’s “Fourth Branch” status raise can come in multiple forms.  They range from the question of how the insulation of SEC Commissioners from Presidential control (because they are not removable “at will”) may affect the SEC’s ability to appoint some officials who operate under its aegis, or to function as a powerful vehicle for enforcing a wide range of laws of the United States, to the question of how the SEC can function simultaneously as the enforcer of those laws and the adjudicator of the enforcement actions it decides to bring while still affording due process to those it prosecutes.

The issue currently at the top of the heap is how the SEC’s establishment as an independent agency impacts its ability to operate administrative courts with judges not subject to the control of the President, and we turn to that now.

The Constitutional Issue Raised About the SEC’s Administrative Law Courts

The current constitutional challenges to SEC proceedings flow from the SEC’s increased use of its administrative law courts to hear major law enforcement proceedings.  Although the constitutional issues discussed below might also apply to SEC administrative proceedings of a more traditional type (involving alleged violations of law by SEC-regulated entities), the intrusion on purely executive functions seems most clear when the “executive” action occurring is a prosecution for violation of the law by persons not otherwise subject to SEC regulation.

Stilwell v. SEC and Peixoto v. SEC involve challenges to the constitutionality of threatened and filed proceedings in the SEC’s administrative law court.  In these cases, the plaintiffs seek declaratory relief that their administrative proceedings would violate Article II of the Constitution because the officials administering those proceedings – SEC administrative law judges – are “officers” of the United States and therefore must be reasonably subject to Executive control under Article II.  Plaintiffs argue (i) the SEC ALJs are “officers” of the United States in the constitutional sense; (ii) the ALJs may be removed from their jobs only “for cause” by the SEC; and (iii) the SEC commissioners can be removed by the President only “for cause.”  This arrangement, it is alleged, so diminishes the President’s ability to control the conduct of executive officers that it violates Article II.

The Constitution

Particularly relevant to this issue are the following provisions of the Constitution:

Article  II, Section 1 vests “The executive Power” “in a President of the United States of America.”

Article II, Section 2, in delineating aspects of the “executive Power,” states that the President “shall nominate, and by and with the Advice and Consent of the Senate, shall appoint Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, and all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Court of Law, or in the Heads of Departments.”

Article II, Section 3 states that the Presidentshall take Care that the Laws be faithfully executed, and shall Commission all the Officers of the United States.”

The Defense Argument

The validity of the defense argument turns on whether the SEC ALJs are “Officers” or “inferior Officers” of the United States, and, if so, whether the President’s inability to remove them “at will,” or reasonably cause someone else to remove them “at will,” impedes his ability to “take Care that the Laws be faithfully executed.”

Free Enterprise Fund  is the Supreme Court precedent most central to this argument.  In that case, the Court considered a constitutionality challenge to the law enforcement powers of the Public Company Accounting Oversight Board (“PCAOB”).  The PCAOB was created in the Sarbanes Oxley Act of 2002 as a government organization with powers to adopt and enforce rules governing the public accounting profession, under the oversight of the SEC.  Its five Board Members are appointed by the SEC.  They are not government employees for statutory purposes, but they were acknowledged by all parties to be “Officers of the United States” who exercised “significant authority pursuant to the laws of the United States.”  561 U.S. at 485-86.  They are removable by a formal order of the SEC only “for good cause shown,” subject to judicial review.  Id. at 486.  As noted above, the parties in the case also stipulated that the SEC Commissioners were removable by the President only for “inefficiency, neglect of duty, or malfeasance in office.”  Id.  at 487.  The case presented the question whether the layering of “for cause” removal restrictions – limiting the President as to “a principal officer” (the SEC Commissioners) “who is in turn restricted in his ability to remove an inferior officer (the PCAOB Members) – is permissible “even though that inferior officer determines the policy and enforces the laws of the United States.”  Id. at 483-84.

The Court found that the appointments of the PCAOB Members did not violate the Appointments Clause because the SEC is a “Department” within the meaning of that clause, noting that “the common, near-contemporary definition of a ‘department’ as a ‘separate allotment or part of business; a distinct province, in which a class of duties are allotted to a particular person’ is consistent with that result even thought the SEC was created as an independent agency.  Id. at 511.  As a result: “Because the Commission is a freestanding component of the Executive Branch, not subordinate to or contained within any other such component, it constitutes a “Departmen[t]” for the purposes of the Appointments Clause.”

But the Court nevertheless concluded that the PCAOB violated Article II because its members were too insulated from presidential control to allow the President to perform his required executive functions: “We hold that such multilevel protection from removal is contrary to Article II’s vesting of the executive power in the President.  The President cannot “take Care that the Laws be faithfully executed” if he cannot oversee the faithfulness of the officers who execute them.  Here, the President cannot remove an officer who enjoys more than one level of good-cause protection, even if the President determines that the officer is neglecting his duties or discharging them improperly.”  Id. at 484.

That raises questions about the SEC’s ALJs.  Under the Administrative Procedure Act, the SEC is responsible for the appointment of the ALJs that preside over its administrative courts.  The SEC is also responsible for their removal.  But it can’t do so “at will.”  5 U.S.C. § 7521 states: “An agency may remove, suspend, reduce in level, reduce in pay, or furlough for 30 days or less an administrative law judge only for good cause established and determined by the [Merit Systems Protection Board] on the record and after opportunity for a hearing before the Board.”  In other words, the SEC’s ALJs are removable by the SEC only after proof of good cause as found by the Merit Systems Protection Board.  In that respect, it appears to be somewhat more difficult for the SEC to remove an ALJ than it is to remove a Member of the PCAOB.

Since no one has yet disputed that SEC Commissioners are removable only for cause, that appears to resolve the issue of whether an ALJ “enjoys more than one level of good-cause protection.”  That would make the dispositive issue whether an SEC ALJ is an “Officer” or an “inferior Officer” of the United States performing executive functions that should be subject to presidential influence.  If he/she is, then by all appearances his/her protection from removal by the President would be “contrary to Article II’s vesting of the executive power in the President” because “[t]he President cannot “take Care that the Laws be faithfully executed.”

Is an Administrative Law Judge an Officer or Inferior Officer of the United States?

Treatment of ALJs in the Free Enterprise Fund decisions.  So is an ALJ an Officer or inferior Officer of the United States?  The Court in Free Enterprise Fund addressed, but did not decide this issue.  Stating that nothing in its opinion “should be read to cast doubt on the use of what is colloquially known as the civil service system within independent agencies,” Justice Roberts devoted a footnote to the impact of the opinion on administrative law judges:

For similar reasons, our holding does not address that subset of independent agency employees who serve as administrative law judges. . . .  Whether administrative law judges are necessarily “Officers of the United States” is disputed.  [See Landry v. FDIC, 204 F.3d 1125 (D.C. Cir. 2000).]  And unlike members of the Board, many administrative law judges of course perform adjudicative rather than enforcement or policymaking functions. . ., or possess purely recommendatory powers.  The Government below refused to identify either “civil service tenure-protected employees in independent agencies” or administrative law judges as “precedent for the PCAOB….”

Free Enterprise Fund, 561 U.S. at 507 n.10.  The Court did “not address” the issue, but it certainly raised a significant obstacle, seemingly suggesting that if ALJs “perform adjudicative rather than enforcement or policymaking functions” they may be constitutionally okay.

The difficulty of getting ALJs included as “officers” is also reflected in Judge Kavanagh’s dissenting opinion in the D.C. Circuit ruling in which the majority rejected the constitutional challenge to the PCAOB.  See Free Enterprise Fund v. PCAOB, 537 F.3d 667 (D.C. Cir. 2008).  Justice Roberts liberally referred to and incorporated arguments from Judge Kavanagh’s dissent as part of his majority Supreme Court opinion, so Judge Kavanagh’s thoughts could be influential.  Here is what he said on the ALJ question (much of which was tracked by Justice Roberts in his footnote):

[A]dministrative law judges in the independent agencies are removable only for cause at the initiation of the agency that employs them and with approval of the Merit Systems Protection Board, . . . whose members in turn are removable only for cause by the President. . . .  [T]here are good reasons the Board and the United States did not cite ALJs as a precedent.  First, an agency has the choice whether to use ALJs for hearings . . . Congress has not imposed ALJs on the Executive Branch.  Second, many ALJs are employees, not officers.  [See Landry v. FDIC, 204 F.3d 1125, 1132-34 (D.C. Cir. 2000)] (ALJs in FDIC are employees because they possess only recommendatory powers that are subject to de novo review by agency).  Third, ALJs perform only adjudicatory functions that are subject to review by agency officials . . . and that arguably would not be considered “central to the functioning of the Executive Branch” for purposes of the Article II removal precedents. . . .  Nothing in this dissenting opinion is intended to or would affect the status of employees in independent agencies who have congressionally mandated civil service tenure protection or the status of administrative law judges.

537 F.3d 667 at 699 n.8 (dissenting opinion).

The opinion in Landry v. FDIC.  Both Justice Roberts’s Supreme Court opinion and Judge Kavanagh’s D.C. Circuit dissent cite only one case in relation to the ALJ issue: Landry v. FDIC, 204 F.3d 1125 (D.C. Cir. 2000).  Kavanagh cites Landry to support the statement that “many ALJs are employees, not officers” and Roberts cites it for the point that “Whether administrative law judges are necessarily ‘Officers of the United States’ is disputed.” Neither judge is suggesting that the holding in Landry decides the issue completely, but it would be important for someone asserting the SEC ALJs are “officers” to be able to explain why the rationale underlying Landry is not especially helpful in evaluating the status of the SEC ALJs.

Landry involved a challenge to sanctions imposed by the FDIC after it reviewed the decision of an FDIC administrative law judge recommending findings and sanctions under the operative FDIC statute.  Among the grounds for appeal to the D.C. Circuit was the contention that the appointment of the FDIC’s ALJ violated the Appointments Clause of the Constitution, Article II, Section 2, Clause 2: “[The President] … shall appoint … Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: 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.”  Landry contended that an FDIC ALJ was an “inferior Officer” who could be appointed only by the President, the Courts, or a Head of Department, but had been appointed by a federal banking agency, which was not a “Department” in the constitutional sense.

 A majority of the D.C. Circuit panel ruled that the FDIC ALJ was not an inferior officer, but was instead a mere “employee.”  The court noted that “[t]he line between ‘mere’ employees and inferior officers is anything but bright. . . .  In fact, the earliest Appointments Clause cases often employed circular logic, granting officer status to an official based in part upon his appointment by the head of a department.”  Landry, 204. F.3d at 1132 (citations omitted).  The Supreme Court’s statement in Buckley v. Valeo, 424 U.S. 1, 126 n.162 (1976), that “any appointee exercising significant authority pursuant to the laws of the United States is an ‘Officer of the United States,’” was treated as not especially helpful.  Instead, “ascertaining the test’s real meaning requires a look at the roles of the employees whose status was at issue in other cases.”  Landry, 204 F.3d at 1133.

 The one case deemed “most analogous” was Freytag v. Commissioner, 501 U.S. 868 (1991), in which the Court found that special trial judges (“STJ”) for the Tax Court were indeed “inferior Officers.”  The Landry majority distinguished Freytag, however, because the Freytag Court relied in part on powers of the STJ not matched by the FDIC ALJs: “the authority to render the final decision of the Tax Court in declaratory judgment proceedings and in certain small-amount tax cases.”  Landry, 204 F.3d at 1133.  Because the FDIC ALJ could only render a recommended decision, findings of fact, and conclusions of law, with final decisions reserved to the FDIC, and because the Supreme Court in Freytag “laid exceptional stress on the STJs’ final decisionmaking power” (id. at 1134), the majority found the ALJ was not an “officer” of the United States.

 Judge Randolph concurred in the result based on no prejudice suffered by the appellant, but strongly disagreed on the determination that the ALJ was not an officer of the United States.  He found the FDIC ALJ indistinguishable in material respects from the Tax Court STJ under the reasoning of the Supreme Court in Freytag.  Quoting the Freytag opinion extensively, he argued that the Supreme Court placed no great importance on the limited respects in which the STJs had final authority.  In particular, the mere fact “that an ALJ cannot render a final decision and is subject to the ultimate supervision of the FDIC shows only that the ALJ shares the common characteristic of the ‘inferior Officer,’” that is that “‘inferior’ officers are officers whose work is directed and supervised at some level by others who were appointed by Presidential nomination….”  Landry, 204 F.3d at 1142 (quoting Edmond v. United States, 520 U.S. 651, 663 (1997).

 In the end, the divided opinion in Landry v. FDIC lends some, but limited, support to the notion that an ALJ whose authority is exclusively limited to recommending determinations to be made finally by others may be an “employee” and not an “inferior Officer.”  But the division in the court makes this far from clear.

 The decision in Freytag v. Commissioner.  Since the Landry decision turns on how the disagreeing judges read the Supreme Court decision in Freytag, we should at least understand what the Freytag court decided.

 As noted above, the Freytag case involved the status of special trial judges (formerly known as “commissioners”) appointed by the Tax Court.  The Tax Court is an Article I court created by Congress with judges appointed for limited terms.  Congress authorized the Chief Judge of the Tax Court to appoint STJs to hear specific types of tax cases, some of which could be decided by the STJ but others of which require a recommended decision by the STJ and final determination by a regular judge of the Tax Court.  Freytag’s case was one of those that required review and adoption by a regular judge, and that is what occurred.

 Freytag challenged the validity of the judgment against him in part because the appointment of STJs by the Chief Judge of the Tax Court violated the Appointments Clause.  The Court unanimously rejected this contention, although it was sharply divided on the reasoning.  A majority of five justices reasoned that the STJ was an “inferior Officer” whose appointment was proper because the Tax Court could properly appoint an inferior officer as one of “the Courts of Law” under Article II, Section 2, Clause 2.  The remaining four justices reasoned that the STJ was an “inferior Officer,” but that the Tax Court’s power to make such appoints derived from the fact that it was a Department within the meaning of Article II, Section 2, Clause 2.  All nine justices, therefore, agreed that the STJs were “inferior Officers.”

The reasoning behind that was laid out in the majority opinion.  That opinion rejected the contention set forth by the Commissioner of the IRS that the STJs were “employees” who did no more than assist the regular Tax Court judges in taking evidence and preparing proposed findings and an opinion.  The Court started with the statement in Buckley v. Valeo, 424 U.S. 1, 126 (1976), that” “Any appointee exercising significant authority pursuant to the laws of the United States is an ‘Officer of the United States,’ and must, therefore, be appointed in the manner prescribed by § 2, cl. 2, of [Article II].”  It went on to reject the argument that STJs are only employees “because they lack authority to enter into a final decision” because that argument “ignores the significance of the duties and discretion that special trial judges possess.”  Freytag, 501 U.S. at 881.  The Court focused on the facts that “the office of special trial judge is ‘established by Law’” and the statute lays out their “duties, salary, and means of appointment for that office” (id.); they “perform more than ministerial tasks” including “tak[ing] testimony, conduct[ing] trials, rul[ing] on the admissibility of evidence, and hav[ing] the power to enforce compliance with discovery orders.”  Id. at 881-82.  And in the course of doing so, they “exercise significant discretion.”  Id. at 882.  These factors were bolstered by others, because “[e]ven if the duties of [STJs] were not as significant as . . . we have found them to be,” there are circumstances where “they exercise independent authority,” and they cannot be “inferior Officers” for some purposes and not others.  See id.

 So, Freytag rejects the argument that officials who “lack authority to enter into a final decision” must be employees and not inferior officers, places great weight on whether a person’s job was created and delineated by statute and involves the exercise of significant discretion, and notes that if this is accompanied by the exercise of “independent authority,” there is no doubt that the official is an inferior officer.

Supreme Court decisions in the military judge cases.  The Supreme Court issued a triumvirate of opinions of relatively recent vintage in cases applying the Appointments Clause to judges presiding over military courts.  See Weiss v. United States, 510 U.S. 163 (1994); Ryder v. United States, 515 U.S. 177 (1995); Edmond v. United States, 520 U.S. 651 (1997).  These cases could be viewed as providing strong support for the view that government officials other than Article III judges who preside over government legal proceedings are to be considered “inferior Officers” of the United States.  (Article III judges almost certainly would be viewed as principal officers.)

Weiss challenged military trial judges who were appointed by the President as officers of the military but never appointed to be judges.  The case proceeded on the “common ground” of the parties, with apparent acquiescence by the Court, that “military judges, because of the authority and responsibilities they possess, act as ‘Officers’ of the United States.”  Weiss, 510 U.S. at 169; see id. at 173 (Buckley, Freytag, and Morrison v. Olson “undoubtedly establish the analytical framework upon which to base the conclusion that a military judge is an ‘officer of the United States’ – a proposition to which both parties agree”).  The Court held that because the appointment as military officers of those serving as judges was consistent with the Appointments Clause, no “reappointment” was required.  The only issue disputed by the justices was how to decide whether the military judges were “inferior Officers” or “principal officers.”  See id. at 182-94 (Souter, J., concurring).

Ryder involved a challenged conviction where the intermediate appellate court, the Coast Guard Court of Military Review, included two civilian judges whose appointments did not comply with the Appointments Clause, and, because they were not military officers, were never appointed to a military office by means consistent with the Appointments clause.  The Court unanimously reversed the decision of the United States Court of Military Appeals (the highest military appellate court) that there were ground to ignore this flaw, and overturned the conviction.  In doing so, the Court agreed that judges serving on the Coast Guard Court of Military Review were officers required to be appointed in accordance with the Appointments Clause.  Significantly, the Court reached this result despite the fact that the intermediate appellate judges in question were subject to review by the higher appellate court, noting that the lower and higher courts applied different standards of review.  Ryder, 515 U.S. at 187-88.

Edmond also involved a challenge to a conviction where the intermediate appellate court (now renamed the Coast Guard Court of Criminal Appeals) included two civilian judges who were assigned to the intermediate court by the Judge Advocate General of the Coast Guard (who also was General Counsel of the Department of Transportation).  After Weiss was decided, the Secretary of Transportation “adopted” the assignments as his own “judicial appointments.”  The Court found no violation of the Appointments Clause because the judges were officers of the Department of Transportation and the power to appoint all such officers was given by statute to the Secretary of Transportation, consistent with the Appointments Clause.  One of petitioner’s challenges was that these judges were “principal officers,” not “inferior officers.”  The Court noted that its “cases have not set forth an exclusive criterion for distinguishing between principal and inferior officers,” and discussed several cases finding other officials to be inferior officers.  Edmond, 520 U.S. at 661.  In response to the argument that these judges exercised “significant authority” on behalf of the United States, the Court that this does not make them principal officers, but draws “the line between officer and non-officer.”  Id. at 662.  The Court concluded they would be “inferior officers” because “[g]enerally speaking, the term ‘inferior officer’ connotes a relationship with some higher ranking officer or officers below the President: whether one is an ‘inferior’ officer depends on whether he has a superior.”  The fact that these judges were subject to administrative oversight by the Judge Advocate General, and could be removed by the Judge Advocate General “without cause,” were strong grounds to show they were subordinates.  Id. at 664.  And the fact that the decisions of the intermediate court were subject to reversal on further appeal, also showed that these judges “have no power to render a final decision on behalf of the United States unless permitted to do so by other executive officers” and are therefore inferior officers.  Id. at 665.  Justice Souter’s concurrence argued that more factors should be considered in determining whether these judges were principal or inferior officers, but in the end agreed “that the judges . . . are inferior officers within the meaning of the Appointments Clause.”  Id. at666-70 (Souter, J., concurring).

The SEC’s ALJs exercise powers of the government and have significant discretion in adjudicating enforcement proceedings involving major sanctions.  Although they are subject to review by the SEC, the cases seem to make it crystal clear that merely being subject to reversal does not render an inferior officer a non-officer.  That their decisions can be reversed is a sign that they are not “principal officers,” but has little bearing on whether they are inferior ones.  To the contrary, in the words of Justice Scalia in Edmond, “we think it evident that ‘inferior officers’ are officers whose work is directed and supervised at some level by others who were appointed by presidential nomination with the advice and consent of the Senate.”  Edmond, 520 U.S. at 663.

 Beyond the case law.  This certainly has not been an exhaustive review of all cases discussing the scope of “inferior Officers.”  But it seems sufficient to conclude that the characterization of the SEC ALJs as inferior officers, on the one hand, or employees, on the other, is not easily made based solely on the cases.  One question to ask is whether there are other authorities addressing the issue that might be helpful.  It turns out that the Office of Legal Counsel of the Department of Justice (OLC) has on several occasions considered how to determine whether certain officials are officers of the United States.  Might these analyses be useful?

 In April 2007, the OLC produced its most recent analysis, a Memorandum Opinion for the General Counsels of the Executive Branch entitled Officers of the United States Within the Meaning of the Appointments Clause (Apr. 16, 2007) (“OLC April 2007 Opinion”).  A copy of that document can be found here: Officers of the United States Within the Meaning of the Appointments Clause – OLC Opinion.  With extensive analysis, the OLC concluded:

 We conclude that any position having the two essential characteristics of a federal “office” is subject to the Appointments Clause.  That is, a position, however labeled, is in fact a federal office if (1) it is invested by legal authority with a portion of the sovereign powers of the federal Government, and (2) it is “continuing.”  A person who would hold such a position must be properly made an “Officer[ ] of the United States” by being appointed pursuant to the procedures specified in the Appointments Clause.

 OLC April 2007 Opinion at 1.

The crux of the OLC analysis is that a person is a federal officer if he or she has a continuing position established by law that involves the application of the sovereign powers of the federal government.  That would be in contrast to a person whose position is “purely advisory” or who “provides goods and services.”  Id.  at 4.  If their official positions involve “the wielding of delegated sovereign authority,” they hold an office, and are officers.  Id. at 7.  Citing historic authorities, the OLC says: “Officers, thus, were persons holding sovereign authority delegated from the King that enabled them in conducting the affairs of government to affect the people “against [their] will, and without [their] leave.”  Id.  at 8.  An influential 19th century treatise cited by the OLC summarized a public office as follows:  “A public office is the right, authority and duty, created and conferred by law, by which for a given period, either fixed by law or enduring at the pleasure of the creating power, an individual is invested with some portion of the sovereign functions of government, to be exercised by him for the benefit of the public. The individual so invested is a public officer.”  Id. at 10 (citing F. Mechem, A Treatise on the Law of Public Offices and Officers § 1, at 1-2 (1890)).

Critically, the OLC emphasizes that “‘independent discretion’ is not a necessary attribute of delegated sovereign authority.”  Id. at 17.  “[T]reating discretion as necessary for the existence of an office conflicts with the original understanding of ‘office,’ early practice, and early precedents.”  Id. at 18.  Nor is the exercise of “independent” authority needed:  “If it is not necessary to the existence of delegated sovereign authority (and thus to the existence of an office) that a position include the exercise of discretion, all the more is it not necessary that a position include some sort of ‘independent’ discretion in carrying out sovereign functions.  The question for purposes of this first element is simply whether a position possesses delegated sovereign authority to act in the first instance, whether or not that act may be subject to direction or review by superior officers.”  Id.

 This OLC opinion, coupled with the Supreme Court decisions in Freytag and Edmond, provides heavy artillery in support of the argument that the SEC ALJs are “inferior Officers” under the Appointments Clause.  They surely are “invested by legal authority with a portion of the sovereign powers of the federal Government.”  They wield governmental power to issue subpoenas and compel testimony.  They determine what evidence should be included in the record, and decide whether portions of the case should proceed to trial or not.  They can sanction lawyers.  In short, they have all the powers of a judge in their courtrooms, and those powers are derived from the sovereign.  They hold “continuing” positions and can only be removed for cause.  They do not appear distinguishable from military judges, and are barely distinguishable from Tax Court special trial judges, or for that matter, from U.S. magistrates.

Do the SEC’s Administrative Law Judges Perform Executive Functions?

Since  the constitutionality issue in Free Enterprise Fund turned on the inability of the President to exercise sufficient influence over the PCAOB’s executive functions, could the SEC’s ALJs be approved on the theory that they do not perform executive functions?  After all, they are serving in a traditional adjudicative capacity, and Justice Roberts did note in his footnote that “unlike members of the Board, many administrative law judges of course perform adjudicative rather than enforcement or policymaking functions. . ..”  Free Enterprise Fund, 561 U.S. at 507 n.10.

Surely that comment provides the opening for an argument, but it is difficult to conceive of the Court concluding that the SEC’s ALJs are not functioning as Executive officers even though they perform key functions in what the Court concluded was an Executive Department.  When the Court decided the Freytag case, it left open whether a “principal agenc[y], such as . . . the Securities and Exchange Commission” is a “Department” under the Appointments Clause.  Freytag, 501 U.S. at 887 n.4.  But with that issue now resolved with the ruling that it is such a Department, it is difficult to create an argument that statutory judges performing adjudicative functions within that Department, just as the special trial judges functioned within the Treasury Department, should be treated as outside of the Executive power.  Likewise, the military court triumvirate of cases all involved officers performing adjudicative functions as part of an arm of the Executive, and it was never suggested that this impacted the importance of their Executive roles.

Because the SEC’s ALJs perform their adjudicative functions as a critical part of executing the SEC’s overall law enforcement authority, which plainly must be considered an executive function, it seems unlikely that the Supreme Court will decide that the adjudicative nature of their functions alone places them outside of the Article II mandate that it is the President who must “take Care that the Laws be faithfully executed.”

Conclusion

 The constitutional challenges raised in the Stilwell and Peixoto cases are far from makeweight.  The Supreme Court decision in Free Enterprise Fund coupled with the SEC’s status as an “independent agency” with Commissioners not subject to removal by the President other than “for cause” seem to make these cases come down to a single issue: are the SEC’s administrative law judges “officers” of the United States performing Executive functions.  A significant line of Supreme Court cases provides apparent support for finding these officials to be “inferior Officers” within the meaning of that clause.  There is also apparent support for this contention from the Department of Justice Office of Legal Counsel opinion addressing the issue of how to decide when a person is an “inferior Officer.”  And the determination that the SEC is to be treated as “a freestanding component of the Executive Branch” leaves little room to conclude that ALJs working for the SEC are not performing Executive functions.

 To be sure, the majority opinion of the D.C. Circuit in Landry, and the footnotes of Justice Roberts and Judge Kavanagh in the Free Enterprise Fund cases noting this to be an open issue, make it clear this is not a slam dunk.  But there can be no doubt that the constitutional issues raised are real and serious, and it seems likely that the Supreme Court will be deciding them relatively soon.

                                                         *                    *                    *

When we next delve into SEC constitutional issues, which may take awhile, we will address why it is that an “independent agency” can exercise enormous power in executing the law through enforcement proceedings even though Article II of the Constitution places the power to “take Care that the Laws be faithfully executed” solely in the hands of a unitary Executive.

 Straight Arrow

 December 2, 2014

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