Opinion ID: 4111397
Heading Depth: 2
Heading Rank: 5

Heading: SEC ALJs Are Inferior Officers Under Freytag

Text: Following Freytag, we conclude SEC ALJs are inferior officers under the Appointments Clause. As the SEC acknowledges, the ALJ who presided over Mr. Bandimere’s hearing was not appointed by the President, a court of law, or a department head. He therefore held his office in conflict with the Appointments Clause when he presided over Mr. Bandimere’s hearing. Freytag held that STJs were inferior officers based on three characteristics. Those - 17 - three characteristics exist here: (1) the position of the SEC ALJ was “established by Law,” Freytag, 501 U.S. at 881 (quoting U.S. Const. art. II, § 2, cl. 2); (2) “the duties, salary, and means of appointment . . . are specified by statute,” id.; and (3) SEC ALJs “exercise significant discretion” in “carrying out . . . important functions,” id. at 882. First, the office of the SEC ALJ was established by law. The APA established the ALJ position. 5 U.S.C. § 556(b)(3). In addition, the Securities and Exchange Act of 1934 authorizes the SEC to delegate “any of its functions” with the exception of rulemaking to ALJs,13 and 17 C.F.R. § 200.14, a regulation promulgated under the Act, gives the agency’s “Office of Administrative Law Judges” power to “conduct hearings” and “proceedings.” See 15 U.S.C. § 78d-1(a) (authorizing SEC to delegate functions to ALJs); 17 C.F.R. § 200.1 (stating statutory basis for SEC regulations). Second, statutes set forth SEC ALJs’ duties, salaries, and means of appointment. 13 The dissent’s concern about how this opinion might affect the SEC ALJs’ role in rulemaking is misplaced. Dissent at 14. SEC ALJs do not have a rulemaking role: the Exchange Act does not allow the SEC to delegate rulemaking authority to its ALJs. 15 U.S.C. § 78d-1(a) (“Nothing in this section shall be deemed . . . to authorize the delegation of the function of rule making . . . .”); see also Raymond J. Lucia Cos., Inc. v. SEC, 832 F.3d 277, 281 (D.C. Cir. 2016) (stating “the authority to delegate [does] not extend to the [SEC’s] rulemaking authority”). Other agencies’ ALJs rarely exercise rulemaking authority. See, e.g., Perez v. Mortg. Brokers Ass’n, 135 S. Ct. 1199, 1222 n.5 (2015) (Thomas, J., concurring) (“Today, . . . formal rulemaking is the Yeti of administrative law. There are isolated sightings of it in the ratemaking context, but elsewhere it proves elusive.”); Kent Barnett, Resolving the ALJ Quandary, 66 Vand. L. Rev. 797 (2013) (“[F]ormal rulemaking is extremely rare . . . .”). Nevertheless, to the extent the dissent is concerned with other ALJs’ rulemaking authority, we do not address the issue because our sole question is whether SEC ALJs are inferior officers. - 18 - 5 U.S.C. §§ 556-57 (duties); id. § 5372(b) (salary); id. §§ 1302, 3105 (means of appointment).14 SEC ALJs are not “hired . . . on a temporary, episodic basis.” Freytag, 501 U.S. at 881. They receive career appointments and can be removed only for good cause. 5 U.S.C. § 7521; 5 C.F.R. § 930.204(a). Third, SEC ALJs exercise significant discretion in performing “important functions” commensurate with the STJs’ functions described in Freytag. SEC ALJs have “authority to do all things necessary and appropriate to discharge his or her duties.”15 This includes authority to shape the administrative record by taking testimony,16 regulating document production and depositions,17 ruling on the admissibility of evidence,18 receiving evidence,19 ruling on dispositive and procedural motions,20 issuing subpoenas,21 and presiding over trial-like hearings.22 When presiding over trial-like 14 The SEC concedes that the way it appoints its ALJs does not comply with the Appointments Clause. SEC Release No. 9972, 2015 WL 6575665 at . 15 17 C.F.R. § 201.111. 16 5 U.S.C. § 556(b), (c)(4). 17 17 C.F.R. §§ 201.230, 201.233. 18 Id. § 556(c)(3); 17 C.F.R. § 200.14(a)(3). 19 17 C.F.R. § 201.111(c). 20 5 U.S.C. § 556(c)(9); 17 C.F.R. §§ 200.14(a)(3), (7), 201.111(h), 201.220, 201.250. 21 5 U.S.C. § 556(c)(2); 17 C.F.R. §§ 200.14(a)(2), 201.111(b). - 19 - hearings, SEC ALJs make credibility findings to which the SEC affords “considerable weight” during agency review.23 They also have authority to issue initial decisions that declare respondents liable and impose sanctions.24 When a respondent does not timely seek agency review, “the action of [the ALJ] shall, for all purposes, including appeal or review thereof, be deemed the action of the Commission.”25 Even when a respondent timely seeks agency review, ______________________________________ Cont. 22 5 U.S.C. § 556(b); 17 C.F.R. § 200.14(a). 23 SEC Release No. 9972, 2015 WL 6575665, at  n.83 (deferring to SEC ALJ’s credibility findings in the face of conflicting testimony). The dissent argues STJs exercise “significant authority” because the Tax Court was “‘required to defer’ to the [STJs’] factual and credibility findings ‘unless they were clearly erroneous,’” Dissent at 3 (quoting Landry, 204 F.3d at 1133). But SEC ALJs’ credibility findings also receive deference. The SEC affords their credibility findings “considerable weight and deference,” Thomas C. Bridge, SEC Release No. 9068, 2009 WL 3100582, at  n.75 (Sept. 29, 2009), and accepts the findings “absent substantial evidence to the contrary,” Steven Altman, SEC Release No. 63306, 2010 WL 5092725, at  (Nov. 10, 2010). See also Robert Thomas Clawson, SEC Release No. 48143, 2003 WL 21539920, at  (July 9, 2003) (stating the SEC “accepts” the ALJs’ credibility findings “absent overwhelming evidence to the contrary”). Both the Tax Court and the SEC defer to credibility findings but are not required to accept those findings if they are undermined by other evidence. Thus, SEC ALJs, like STJs, exercise significant authority in part because the SEC defers to their credibility findings. 24 5 U.S.C. § 556(c)(10); 17 C.F.R. §§ 200.14(a)(8), 200.30-9(a), 201.111(i), 201.360; see also SEC Release No. 507, 2013 WL 5553898. 25 15 U.S.C. § 78d-1(c). The SEC and the dissent argue the SEC ALJs do not exercise significant authority when issuing initial decisions because the agency retains a right to review the decisions de novo. But this argument is incomplete. The agency has discretion to engage in de novo review, 15 U.S.C. § 78d-1(b), but also has discretion not Continued . . . - 20 - the agency may decline to review initial decisions adjudicating certain categories of cases.26 Further, SEC ALJs have power to enter default judgments27 and otherwise steer the outcome of proceedings by holding and requiring attendance at settlement conferences.28 They also have authority to set aside, make permanent, limit, or suspend temporary sanctions that the SEC itself has imposed.29 ______________________________________ Cont. to engage in de novo review before an initial decision becomes final, 17 C.F.R. § 201.360(d)(2) (stating the agency can make an initial decision final by entering an order). In fact, the agency has no duty, based on the regulation’s plain language, to review an unchallenged initial decision before entering an order stating the decision is final. 17 C.F.R. § 201.360(d)(2). Thus, SEC ALJs exercise significant authority in part because their initial decisions can and do become final without plenary agency review. Indeed, 90 percent of those initial decisions become final without plenary review. SEC, ALJ Initial Decisions, https://www.sec.gov/alj/aljdec.shtml (archiving initial decisions); see also Amici Br. at 13-14. Further, an SEC ALJ’s authority to issue an initial decision is significant because, even if reviewed de novo, the ALJ plays a significant role as detailed above in conducting proceedings and developing the record leading to the decision, and the decision publicly states whether respondents have violated securities laws and imposes penalties for violations. Id. § 201.360(c) (requiring the agency to publish the initial decision on the SEC docket). 26 17 C.F.R. § 201.411(b)(2). 27 17 C.F.R. § 201.155. 28 5 U.S.C. § 556(c)(6), (8); 17 C.F.R. § 201.111(e). 29 17 C.F.R. §§ 200.30-9, 201.531; see also 15 U.S.C. § 78u-3(c) (describing temporary order); 17 C.F.R. § 201.101(a)(11) (stating a temporary sanction is “a temporary cease-and-desist order or a temporary suspension of . . . registration”); id. Continued . . . - 21 - In sum, SEC ALJs closely resemble the STJs described in Freytag. Both occupy offices established by law; both have duties, salaries, and means of appointment specified by statute; and both exercise significant discretion while performing “important functions” that are “more than ministerial tasks.” Freytag, 501 U.S. at 881-82; see also Samuels, 930 F.2d at 986. Further, both perform similar adjudicative functions as set out above.30 We therefore hold that the SEC ALJs are inferior officers who must be appointed in conformity with the Appointments Clause.31 ______________________________________ Cont. §§ 201.510(b), 201.512(a), 201.521(b), 201.522(a) (describing a temporary sanction and stating an SEC commissioner presides over the hearing and that the agency must issue the order); id. § 201.531(a)(1) (stating an initial decision “shall specify” which terms or conditions of a temporary sanction “shall become permanent”); id. § 201.531(a)(2) (stating an initial decision “shall specify” “whether a temporary suspension of a respondent’s registration, if any, shall be made permanent”); id. § 201.531(b) (stating an order modifying a temporary sanction “shall be effective 14 days after service” (emphasis added)). 30 The dissent complains that the majority opinion “lists the duties of SEC ALJs, without telling us which, if any, were more important to its decision than others and why.” Dissent at 11. But this misses the point of our following Freytag. There, the Court identified four duties that supported the STJs’ inferior officer status: “They take testimony, conduct trials, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders.” 501 U.S. at 881-82. We point out above that SEC ALJs perform comparable duties, and we spell out even more of their discretionary functions. 31 Those who challenge agency action typically have the burden to show prejudicial error. 5 U.S.C. § 706; Shinseki v. Sanders, 556 U.S. 396, 406-07 (2009). The error here is structural because the Supreme Court has recognized the separation of powers as a “structural safeguard.” Plaut v. Spendthrift Farm, Inc., 514 U.S. 211, 239 (1995) (emphasis omitted). Structural errors are not subject to prejudicial-error review. Continued . . . - 22 - This holding serves the purposes of the Appointments Clause. The current ALJ hiring process whereby the OPM screens applicants, proposes three finalists to the SEC, and then leaves it to somebody at the agency to pick one, is a diffuse process that does not lend itself to the accountability that the Appointments Clause was written to secure. In other words, it is unclear where the appointment buck stops. The current hiring system would suffice under the Constitution if SEC ALJs were employees, but we hold under Freytag that they are inferior officers who must be appointed as the Constitution commands. As the Supreme Court said in Freytag, “The Appointments Clause prevents Congress from dispensing power too freely; it limits the universe of eligible recipients of the power to appoint.” 501 U.S. at 880.