Supreme Court Finds the SEC’s In-House Enforcement Proceedings To Be Unconstitutional: An Easy Fix

On June 21, 2018, the U.S. Supreme Court handed down its decision in Lucia v. Securities and Exchange Commission, finding that the SEC’s system of appointing administrative law judges (ALJs) by the SEC staff, rather than by the SEC commissioners themselves, is unconstitutional.   The case resolved a split between the U.S. Courts of Appeals for the D.C. and Tenth Circuits and has been closely watched by the securities industry because of the SEC’s controversial practice of bringing enforcement actions as in-house enforcement proceedings before ALJs, rather than in the federal courts.

The case began when the SEC brought an enforcement proceeding against Raymond Lucia, who had marketed a retirement savings strategy he called “Buckets of Money.”  The SEC found that Lucia had used misleading slideshow presentations to deceive prospective clients, and after a trial before an ALJ, the ALJ issued a decision imposing civil penalties of $300,000 and barring Lucia from the securities industry for life.  The SEC then remanded the case to the same ALJ for further findings of fact, and the ALJ made additional findings of deceptive conduct by Lucia and returned a decision imposing the same sanctions.

On appeal directly to the SEC’s commissioners, Lucia argued that the administrative law judges are “Officers of the United States” under the Appointments Clause of the U.S. Constitution, and that therefore they must be appointed by the President of the United States, the courts of law, or “Heads of Departments” – i.e., the commissioners themselves, rather than the SEC staff.  The SEC rejected this argument, finding that the ALJs were not “Officers” but rather “mere employees.”  Lucia took his case to the D.C. Circuit, which agreed with the SEC, and split evenly upon en banc review by the full court, again resulting in the denial of Lucia’s claim.

The Supreme Court agreed to hear Lucia’s case, because the result in the D.C. Circuit conflicted with the result in Bandimere v. SEC, a 2016 Tenth Circuit case in which the appeals court had held that the ALJs are, in fact, “Officers” under the Appointments Clause.  The Supreme Court found that the question was easily addressed by applying its earlier decision in Freytag v. Commissioner, 501 U. S. 868 (1991), where the Court had resolved the analogous question of whether the “special trial judges” of the United States Tax Court were Officers under the Appointments Clause.  Applying Freytag, as well as earlier precedents, the Supreme Court found that the SEC ALJs were “Officers,” because they hold a “continuing office established by law” and they possess “significant authority” – in other words, they possess “significant discretion” when carrying out “important functions.”  Because the ALJs were not appointed properly under the Appointments Clause, the decision against Lucia was invalidated, and the case was remanded for a new trial by a properly appointed ALJ.

The SEC’s administrative proceedings have become highly controversial in recent years, as many defendants in these proceedings have argued that the process is inherently unfair.  In the administrative proceedings, discovery is limited and depositions are generally not permitted to be taken by defense attorneys.  There are no juries. Perhaps the most significant criticism is that both the judge and the prosecutor are employees of the SEC, and appeals must be taken directly to the SEC commissioners, and only then to a federal court of appeals.

While the Lucia case represents a win for Mr. Lucia, it rings hollow for virtually everyone else who has been, or will be, subject to the SEC’s administrative proceedings.  The SEC not only ratified the staff’s appointment of its five ALJs during the pendency of Lucia’s case, but also will no doubt now take care to appoint all ALJs properly in the future, removing the constitutional infirmity found by the Court.