Beyond Lucia: The Supreme Court’s Decision Is Just the Beginning

From Ulmer’s Broker-Dealer Law Corner Blog
By Kenneth F. Berg

Here is an important post by my partner, Ken Berg, regarding SEC administrative proceedings, and what we can expect following the Supreme Court’s recent decision in Lucia. – Alan

By now everyone knows the US Supreme Court declared the SEC’s administrative proceedings unconstitutional because the ALJs were improperly hired by the SEC staff instead of being appointed by the Commissioners. All respondents who raised this constitutional issue before the SEC, who have not settled, and whose cases are not yet final, are entitled to a new evidentiary hearing before a different ALJ. But, here are a couple of questions the Supreme Court did not address in Lucia v. SEC and that decision may be just the beginning of the SEC’s troubles.

First. What about respondents who did not raise the issue before the SEC? If they did not settle and their cases are not final, are they entitled to a new hearing before a different ALJ? Looks good. This issue is currently pending before the Tenth Circuit in a case argued by Ulmer and awaiting decision, Malouf v. SEC. Ulmer argued even though Malouf’s former attorney did not raise the Appointment Clause issue before the SEC, the Court of Appeals can reverse because there were “reasonable grounds” for not doing so. At oral argument, at least two of the three judges were openly skeptical of the SEC’s position that the Court of Appeals could not reverse. Judge Hartz said to the lawyer representing the SEC, “Help me get comfortable with your position.” The Judge was troubled because even if the constitutional issue had been raised before the SEC, the agency “almost certainly would have ignored it.” Judge Bacharach challenged the SEC’s attorney, saying “I can’t think of a new argument that could be more futile to make than that everything [the SEC has] before [it] is invalid ….” This bodes well for respondents getting a new hearing before a different ALJ even if they did not assert the Appointments Clause defense at the SEC.

Second. Did the SEC fix the constitutional problems when it appointed the sitting ALJs in November 2017?  Probably not. In addition to being appointed incorrectly, there are other constitutional problems with the way SEC ALJs can be removed. The Supreme Court did not address this issue. (See Judge Breyer’s separate opinion.) The Appointments Clause not only requires ALJs to be appointed by the President or the Commissioners, it also requires that the President be able to remove ALJs. However, ALJs can only be removed “for cause” (meaning they are not doing their job) and ALJs are entitled to a hearing at the Merit Systems Protection Board before they can be removed. These multiple levels of protection from removal violate the Appointments Clause. Unlike the defect in appointing ALJs, the fix for the removal problem may not be within the SEC’s power and may require an act of Congress amending the Administrative Procedure Act. Until that happens, all administrative proceedings at the SEC go forward at the risk of having to be redone.  Accordingly, all respondents should assert an appointments clause defense as early in the proceedings as possible even after Lucia.

Third. Does the five-year statute of limitations applicable to SEC enforcement proceedings bar retrying a case before a different ALJ? Worth arguing. SEC proceedings are commenced by the Commissioners issuing an Order Instituting Proceedings (“OIP”). The OIP must be issued within five years of the allegedly unlawful conduct and it determines whether the case will proceed administratively or in district court. The Appointments Clause “invalidates actions taken pursuant to defective title.” Ryder v. US, 515 US 177, 185 (1995). An OIP issued before November 2017, when there were no constitutionally appointed ALJs, is void and did not commence an action. Retrying a respondent before a different ALJ requires issuance of a new OIP. But if the new OIP is issued more than five years after the allegedly unlawful conduct, then the proceedings are barred by the statute of limitations. Accordingly, an unintended consequence of the Supreme Court’s decision in Lucia is that he and others similarly situated may be completely off-the-hook.