SEC Abruptly Changes Position on ALJs

05 Dec SEC Abruptly Changes Position on ALJs

Posted at 18:28h in Securities Litigation & Regulation by

The SEC last week abruptly changed its position on the status of its administrative law judges (“ALJs”).  In a Supreme Court brief filed in the case of Lucia v. Securities and Exchange Commission, the SEC conceded that its ALJs are indeed inferior officers requiring appointment by the Commissioners in accordance with the Appointments Clause of Article 2 of the U.S. Constitution.  Until filing its brief, the Commission had long maintained that its ALJs are mere employees, who were properly appointed through a process overseen by the Office of Personnel Management and the Chief ALJ.  The Commission’s reversal of position represents not only a sea change that the agency arrived at only after losing the issue in the 10th Circuit and having Lucia’s request for en banc hearing denied by the DC Circuit, where the Commission had previously prevailed, but it also has the potential to unravel the same or similar appointments process used by many other federal agencies.

Should the Supreme Court take up the central issue in Lucia and agree that SEC ALJs are indeed officers, what ripple effect might it cause across the federal administrative landscape?  Might respondents from previously settled or adjudicated matters seek to challenge the outcome of their cases?  Might respondents in cases before other agencies that appoint ALJs using a system similar to the SEC’s challenge the legitimacy of the ALJ in their proceedings?  Considering that the Social Security Administration alone has more than 1,500 ALJs who, in fiscal 2016, adjudicated more than 636,285 cases, while the SEC itself adjudicated 170 cases, a flood of challenges across the government could overwhelm the federal administrative bureaucracy.  Some of the other agencies that use a similar hiring process for ALJs –though by no means all — include the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corp., and the Environmental Protection Agency.  In light of this, it’s unlikely the Supreme Court will be eager to rule on the issue or, if it does take up the case, to issue a broad ruling, which might revive long settled or decided matters and cause great confusion and delay in currently pending federal administrative matters.

For what benefit might the Court open the doors to this potential tsunami of re-litigation?  To preserve the structural integrity of Article 2 of the Constitution, which mandates that the president faithfully execute the laws of the United States.  To satisfy this goal, the president must have the ability to remove any executive branch official who frustrates his constitutional mandate, i.e., they must be accountable.  This is achieved by having officers who exercise significant federal authority, such as SEC ALJs — according to the Commission’s new position — directly accountable to the president, or to his Senate confirmed Principal Officers.  In the case of the SEC, that means having Commissioners, who are confirmed by the Senate, have the ability to remove a rogue ALJ.

Currently, SEC ALJs are two levels removed from presidential reach.  At the first level, they are insulated from presidential reach by being subordinate to the SEC Commissioners.  In order for the president to remove a rogue ALJ, he would have to go through the SEC Commissioners; he cannot simply reach into the agency and remove an employee he did not appoint.  Even then, because ALJs enjoy the same protections afforded other federal employees, including the right to due process and the protection from removal without just cause, they enjoy a second level of protection.  In short, were an ALJ to “go rogue” to an extent where the executive branch, personified by the president, believed the ALJ was no longer faithfully applying the laws of the United States, the president could not affect a swift removal.  In the case of Freytag v. IRS Commissioner, the Supreme Court held that because ALJs were established by congressional action, to be appointed and overseen by the executive branch, their appointment and removal implicates a separation of powers issue, which is never waived or removed.

How real is the risk of needing to remove a rogue ALJ?  At the SEC, there have been no reports in recent history of an ALJ becoming the source of concern for not following the law to such as extent that s/he was viewed as betraying the obligation to faithfully execute federal law.  There are often cases, as in other litigation contexts, where a losing or disgruntled party believes the judge either misinterpreted the facts or law, or otherwise did not get something right.  But, that is not unusual, nor has it risen to a level where concern has been raised about any particular judge’s competence, understanding or disobedience of the law.  In other words, though the issue of removal is, technically, ever present, and raises legitimate accountability issues, it is not a “live” issue, making recent challenges to ALJ legitimacy more a matter of defense strategy than the search for a cure to a current problem.

Nonetheless, to mollify critics, and perhaps dissuade the Court from going too far in any potential ruling in Lucia, the day after filing its brief the SEC announced that the Commissioners had ratified the appointments of all of the agency’s ALJs, effectively mooting the need for judicial action.  However, this won’t settle the question of whether there was ever a need to do so.  But, it will insulate the Commission from continuing and near-term challenges on the issue.  In a nod to the adage “be careful what you wish for,” respondents who have attacked the agency’s process should be mindful that by making ALJs directly accountable to the political process, through political appointees, political pressure could begin to creep into a process that throughout the agency’s history has never been present, i.e., that was a rare as the rogue ALJ.

(This blog is a companion piece to a December 4, 2017 article published in the Daily Journal, titled “About-face on SEC in-house judges is startling.”)

Ron Wood

Ron Wood

Ron Wood is a partner with Brown White & Osborn LLP. A former Assistant Director in the SEC's Division of Enforcement, Executive Director in the Law Division at Morgan Stanley, and litigation partner with Proskauer LLP, he practices securities law with a focus on regulatory and enforcement matters. He also conducts internal investigations and complex commercial litigation.
Ron Wood

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