ANALYSIS: Lack of Removal Power Could Threaten SEC ALJ Regime

Oct. 7, 2019, 10:48 AM

Are the job security provisions enjoyed by SEC administrative law judges unconstitutional? The Supreme Court majority kicked that question down the line in its 2018 Lucia v. SEC decision. The Fifth Circuit may just have picked it up, as a three-judge panel enjoined an administrative rehearing of a pre-Lucia accounting violations case against Michelle Cochran. It is too early in the process to read too much into a preliminary injunction, but the Fifth Circuit’s action does indicate that Lucia has not yet been laid to rest.

The Lucia Legacy

In Lucia, as described here, the Supreme Court held that SEC ALJs are “Officers of the United States,” and not mere employees of the federal government. As such, under the constitution’s appointments clause, they could only be appointed by the president, a court of law, or the head of a department. The SEC practice at the time of having the SEC’s Chief ALJ select new judges did not pass constitutional muster.

The high court declined to answer the question put forth by the Solicitor General of whether the constitution prohibited the statutory “for cause” removal protections that Congress provided for administrative law judges. In Free Enterprise Fund v. PCAOB, the Court held in 2009 that Congress could not provide members of the PCAOB with “multilevel protection from removal” by the president. The Court neatly solved the problem, by severing the removal provisions from the rest of the Sarbanes-Oxley Act language and invalidating them. The PCAOB survived, but the SEC may now remove its members for any reason without a “for cause” restriction.

The matter is not so simple with regard to ALJs. Critics have long claimed that the SEC has a significant “home court advantage” when trying cases before its in-house judges rather than federal district courts. The SEC asserts that its judges are independent from the Commission, and the fact that the judges may only be removed for good cause by an independent agency, the Merit Systems Protection Board, supports that claim. If the Supreme Court struck down the ALJs’ job protections, the impact on administrative enforcement would be profound. As Justice Breyer noted in his Lucia concurrence, the elimination of the tenure protections would “would risk transforming administrative law judges from independent adjudicators into dependent decisionmakers, serving at the pleasure of the Commission.” He noted that such a holding would allow “the Commission to remove an administrative law judge with whose judgments it disagrees—say, because the judge did not find a securities law violation where the Commission thought there was one, or vice versa.”

What’s Next?

The SEC Enforcement Division reduced the number of actions brought as administrative cases after Lucia. In a recent interview, SEC Co-Enforcement Director Steven Peikin told me that the division would continue to bring matters such as insider trading and financial fraud to federal district court, while it would refer cases seeking special remedies, such as officer or director bars, for administrative hearings.

The Cochrane case seems tailor-made for administrative prosecution. The case involves the fitness of an accountant to practice before the Commission and sanctions for accounting violations.The Fifth Circuit has presently stopped the administrative action pending its decision. If the appellate panel sides with Cochran, and the issue makes its way upward, the Supreme Court may well strike down the ALJ job protections. If ALJ independence ends, so effectively does the agency’s administrative enforcement program.

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