Source: https://securitiesdiary.com/tag/constitution/
Timestamp: 2019-04-21 10:38:55+00:00

Document:
Southern District of New York federal Judge Richard Berman yesterday decided that Barbara Duka, a former Standard & Poor’s employee charged with securities law violations by the SEC, cannot enjoin the SEC administrative enforcement action brought against her. In doing so, Judge Berman rejected the argument that he lacked jurisdiction over the case, unlike two previous federal court judges. See SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding, and Court Dismisses “Compelling and Meritorious” Bebo Constitutional Claims Solely on Jurisdictional Grounds. As a result, he addressed the merits of Ms. Duka’s constitutional argument, finding the she was “unlikely to succeed on the merits” of that claim. Likely success on the merits of the claim is a requirement for granting the preliminary injunctive relief sought by Ms. Duka. The opinion is available here: Order Denying Relief in Duka v. SEC.
Judge Berman rejected the jurisdictional argument accepted by two prior judges because, unlike them, he concluded that the relief sought by Ms. Duka could not be satisfied within the administrative adjudication process, the challenge made addressed not the substance of the claims against her but the very suitability of the forum to adjudicate those claims, and the constitutional issue fell outside of the SEC’s area of expertise.
The Court concludes that the absence of subject matter jurisdiction “could foreclose all meaningful judicial review” of Plaintiff’s claim. . . . The Court of Appeals obviously would not be able, upon appellate review of any final SEC order, to enjoin the SEC from conducting the Administrative Proceeding, as Duka asks this Court to do. And, while the Court of Appeals could, presumably, vacate an adverse decision (order) by the SEC on constitutional grounds, it would be unable to remedy the harm alleged by Plaintiff in this Court, i.e., the “substantial litigation and resource burdens incurred during [the] administrative proceeding,” and the “reputational harm” associated with her defending the Administrative Proceeding. . . .
Plaintiff is not here challenging the outcome of her Administrative Proceeding or any order(s) issued by the SEC. Rather, Plaintiff seeks to enjoin the proceeding itself, and the (injunctive and declaratory) relief she seeks is to prevent the Administrative Proceeding from occurring in the first place. . . . If Plaintiff were required, as the Government urges, to await the completion of the Administrative Proceeding to seek (any) judicial intervention, important remedies could be foreclosed. That is, her claim for injunctive and declaratory relief would likely be moot at that stage because the allegedly unconstitutional Administrative Proceeding would have already taken place. Simply put, there would be no proceeding to enjoin. . . .
Slip op. at 10-12 (cites and footnotes omitted).
The Court concludes that Plaintiff’s claim for injunctive and declaratory relief is “wholly collateral” to “any Commission orders or rules from which review might be sought” in the Court of Appeals. . . . In Free Enterprise, the Supreme Court found that the petitioners’ Article II claim was collateral because “petitioners object[ed] to the Board’s existence, not to any of its auditing standards.”. . . Similarly, Duka contends that her Administrative Proceeding may not constitutionally take place, and she does not attack any order that may be issued in her Administrative Proceeding relating to “the outcome of the SEC action.” Chau [v. SEC], 2014 WL 6984236, at *13; see Gupta [v. SEC], 796 F. Supp. 2d at 513 (where plaintiff “would state a claim even if [he] were entirely guilty of the charges made against him . . . .”).
Unlike the plaintiffs in Chau, Duka does not assert an “as-applied” challenge to agency action “in light of the facts of a specific case.” Chau, 2014 WL 6984236, at *6. Rather, she contends that Administrative Proceedings are “unconstitutional in all instances—a facial challenge.” Id. As Judge Kaplan noted in Chau, “courts are more likely to sustain preenforcement jurisdiction over broad facial and systematic challenges.” Id. (internal quotation marks omitted).
Without in any way diminishing ALJ Elliot’s exceptional legal background, the Court concludes that the constitutional claim posed in this injunctive/declaratory judgment case is outside the SEC’s expertise. This aspect of executive agency practice is governed by clear Supreme Court precedent. See Thunder Basin [Coal Co. v. Reich], 510 U.S. at 215 (“[A]djudication of the constitutionality of congressional enactments has generally been thought beyond the jurisdiction of administrative agencies.”); see also Free Enterprise [Fund v. Pub. Co. Accounting Oversight Bd.], 561 U.S. at 491 (“Petitioners’ constitutional claims are also outside the Commission’s competence and expertise . . . . [T]he statutory questions involved do not require ‘technical considerations of [agency] policy’. . . . They are instead standard questions of administrative law, which the courts are at no disadvantage in answering.”).
When he turned to the merits of the constitutional issue, Judge Berman was unwilling to apply the Supreme Court’s Free Enterprise Fund decision to the SEC’s administrative law judges. Not, however, because he doubted that SEC ALJ’s are “inferior officers” of the Executive Branch in constitutional terms. He did not decide that issue, because he said it was unnecessary, but plainly viewed prior Supreme Court precedent regarding Tax Court special trial judges in Freytag v. Commissioner likely to be determinative: “The Supreme Court’s decision in Freytag v. Commissioner, 501 U.S. 868 (1991), which held that a Special Trial Judge of the Tax Court was an “inferior officer” under Article II, would appear to support the conclusion that SEC ALJs are also inferior officers. See Freytag, 501 U.S. at 881–82 (“[S]pecial trial judges perform more than ministerial tasks. They take testimony, conduct trials, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders. In the course of carrying out these important functions, the special trial judges exercise significant discretion.”). Slip op. at 16. As noted, however, Judge Berman decided he “need not resolve that issue.” Id.
That is because he reasoned that even if the SEC’s ALJ’s are inferior officers, the double-layer of removal protection they are accorded by statute does not undermine the President’s Executive power. He noted that the Free Enterprise Fund Court “specifically excluded ALJs from the reach of its holding,” and rejected Ms. Duka’s argument that Free Enterprise Fund established a “categorical rule” forbidding two levels of “good cause” tenure protection. Slip op. at 17.
Instead, Judge Berman created “a functional test to determine whether and when statutory limitations on the President’s power to remove executive officers violate Article II” based on other Supreme Court precedent. He relied on the Supreme Court’s special prosecutor case, Morrison v. Olson, 487 U.S. 654 (1988), to argue for a test focused on whether Congress “interfere[d] with the President’s exercise of the ‘executive power’ under Article II” (quoting Morrison, 487 U.S. at 689-90). Although Free Enterprise Fund had no similar language regarding the double-layer of removal protection, Judge Berman argued that the Free Enterprise Fund decision “likewise focused upon whether the statutory restrictions on removal of PCAOB members were so structured as to infringe the President’s constitutional authority by ‘depriv[ing] the President of adequate control over the Board.’ Free Enterprise, 561 U.S. at 508.” Slip op. at 17-18.
Indeed, he argues that if the President could dismiss ALJ’s without cause, that would “undermine” the agency adjudication process, citing an article by Elena Kagan, written before she became a Supreme Court justice. Slip op. at 21.
Having elided the issue of whether the SEC ALJs are “inferior officers,” the opinion strikes me as somewhat superficial and relatively weak effort at resolving the constitutional issues that arise if they are, indeed, officers in the Executive Branch. Judge Berman dispenses with this issue in a mere 4-1/2 double-spaced pages. His treatments of the Supreme Court decisions in Morrison v. Olson, Wiener v. United States, and the grandfather of them all, Humphrey’s Executor v. United States, are largely superficial. In Judge Berman’s view, the fact that ALJ’s perform their executive duties as part of an adjudicative process insulates them from the need for control or influence by the Chief Executive. He makes no real effort to examine the constitutional consequences of exempting large numbers of Executive Department officers from the need for Presidential control, and fails even to address the conundrum of treating an Executive Department officer within a law enforcement agency as if he or she were just another judge. The nuances of how to accord administrative judges the freedom to act as an independent judicial branch within a powerful law enforcement department of the Executive Branch are basically ignored. In sum, the effort lacks the depth and studiousness of an opinion likely to persuade appellate courts, and possibly other district courts as well. It may well be that a proper, complete, and thorough argument along these lines can be made, but it is not reflected in this opinion.
Judge Berman effectively creates an adjudicative exception to the need for Presidential control over “inferior officers” involved in an adjudicative process within the Executive Branch. That is, essentially, formed out of whole cloth. His core argument — “that congressional restrictions upon the President’s ability to remove ‘quasi judicial’ agency adjudicators are unlikely to interfere with the President’s ability to perform his executive duties” — is pure ipse dixit. Short references to Humphrey’s Executor, Wiener, and Morrison, none of which involved facts and circumstances even vaguely like this case, hardly suffice to justify such a broad-reaching conclusion. Many of the Supreme Court decisions addressing the role of the Executive in non-Article III courts are not examined, or even mentioned. Included among these is the separation of powers discussion in Freytag v. Commissioner, which Judge Berman acknowledged in the first part of his opinion and ignored thereafter (Freytag has an extensive discussion of the separation of powers implications of performing adjudicative functions outside in non-Article III courts). Since Free Enterprise Fund plainly treats the SEC as an Executive Department, and there is abundant case law addressing the constitutional treatment of non-Article III courts, an in-depth analysis of those cases would seem necessary before reaching Judge Berman’s conclusions. I haven’t delved into those cases any more than he does (which is to say, not at all), but I’m certain that a reasoned resolution of the issue requires a lot more spade work than I see reflected in Judge Berman’s four pages on the issue.
Judge Berman’s decision also proceeds on the assumption that it is not important – and, indeed, could be harmful – for the President to be able to exercise authority over officials within the Executive Branch who perform adjudicative-like functions. That fails totally to consider the context in which the SEC ALJs function. Judge Berman seems to think all ALJs perform the same kind of function, and none of them do things the Chief Executive cares much about. But some ALJs, like those in the SEC, are critical cogs in a law enforcement process addressing large portions of the Nation’s economic and financial infrastructure. They play a critical role in an Executive process to enforce the law, and exercise considerable discretion in doing so, without any direct supervisors. The SEC’s enforcement actions already proceed with, at best, limited input from, or control by, the President. To the contrary, the SEC touts itself as being “independent” of the President. If the SEC’s ALJs are, indeed, executive officers playing key roles in implementing a quintessentially executive function – the enforcement of the laws – why does the fact that ALJs follow an adjudicative-like process as part of that function mean they should be doubly insulated from Presidential influence? Judge Berman effectively postulates this as a necessary aspect of having an agency-based adjudicatory function, but the stated support for that – even if it is a law review article by Elena Kagan — is slim indeed, putting aside whether the very concept of an independent judiciary, functioning within an independent law enforcement agency, has any place in Articles I, II, or III of the Constitution.
There also is no mention or apparent consideration of potential Appointments Clause issues in this context. That may well be because Ms. Duka’s counsel never pressed those issues. But if the SEC’s ALJs are officers of the Executive Branch, the Appointments Clause applies, and it is not at all clear whether the appointment process for SEC ALJs complies with that process.
To be sure, this decision represents a victory for the SEC in another battle in this campaign. The loss on the jurisdiction issue is more than outweighed by the favorable ruling on the merits issue. (Although it may encourage the DC Circuit to reach the merits of the constitutional issue in the recently-argued appeal in Jarkesy v. SEC). The approach taken by the court does suggest that the SEC may not fare well in its arguments that its administrative law judges are not “inferior officers,” but the overall rejection of the Free Enterprise Fund double-insulation theory provides the groundwork for future SEC arguments on the merits in other courts. One of those courts may take the time and make the effort to provide a more thorough consideration of the merits issue, but for now, count this as a significant, if not definitive, victory for the Commission.
This entry was posted in Administrative Proceedings, SEC Enforcement, Securities Law and tagged administrative courts, administrative law judge, administrative proceeding, ALJ, Appointments Clause, Article II, Barbara Duka, Bebo, Bebo v. SEC, Chau, Chau v. SEC, Constitution, constitutionality, DC Circuit, Duka, Duka v. SEC, Enforcement Division, Free Enterprise Fund, Free Enterprise Fund v. PCAOB, Freytag v. Commissioner, injunction, Jarkesy, Jarkesy v. SEC, Judge Berman, Judge Kaplan, jurisdiction, lawyer, legal analysis, likelihood of success on the merits, PCAOB, preliminary injunction, S&P, SDNY, SEC, SEC enforcement, securities, securities fraud, securities law, securities litigation, separation of powers, Standard & Poors on April 16, 2015 by Straight Arrow.
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.
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.
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.
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.
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 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 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.
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.
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.
Is an Administrative Law Judge an Officer or Inferior Officer of the United States?
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.
[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.
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.
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?
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.
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.
This entry was posted in Enforcement Overreaching, SEC Enforcement, Securities Law and tagged administrative courts, ALJ, Appointments Clause, Article II, Chau v. SEC, Constitution, constitutionality, due process, Edmond v. United States, Enforcement Division, Free Enterprise Fund, Freytag v. Commissioner, Landry v. FDIC, lawyer, Peixoto, Peixoto v. SEC, Ryder v. United States, SEC, SEC enforcement, securities, Securities Act of 1933, Securities Exchange Act of 1934, securities fraud, securities law, securities litigation, separation of powers, Stilwell, Stilwell v. SEC, Weiss v. United States, Wing Chau on December 2, 2014 by Straight Arrow.

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