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Supreme Court rules SEC in-house judges are subject to appointments clause

The American flag flies at half-staff in front of the U.S. Supreme Court building in Washington, D.C., U.S., on Tuesday, Feb. 16, 2016 Justice Antonin Scalia’s unexpected death, and Senate Republicans’ refusal to confirm a successor while President Barack Obama is in office, threatens to ignite a year-long battle over the court’s future. Photographer: Andrew Harrer/Bloomberg

The Securities and Exchange Commission's use of in-house administrative law judges could be in for a major change, with the Supreme Court ruling Thursday that they are not just employees but officers subject to the Constitution's appointments clause.

The Supreme Court challenge was brought by former investment adviser Raymond Lucia, who was banned from the industry for life by an SEC administrative law judge in 2013 for alleged misrepresentations in a "buckets of money" retirement wealth management strategy. Mr. Lucia argued that the case should be overturned because the in-house judge was not properly appointed.

The Supreme Court's 7-2 decision in an opinion written by Justice Elena Kagan reversed and remanded a June 2017 split 5-5 decision by the U.S. Court of Appeals for the District of Columbia Circuit that upheld the SEC's in-house courts on constitutional grounds.

The Supreme Court heard the case in part because of an opposite ruling by a 10th U.S. Circuit Court of Appeals panel in Denver, which found that the administrative law judge hiring process violates the Constitution.

The SEC said it's reviewing the decision.

Last November, the federal government reversed its position on such challenges, with the solicitor general agreeing that the in-house judges are inferior officers who should be subject to the appointments provision, which governs how government agencies hire the judges. That prompted the SEC to ratify its prior appointment of the five current administrative law judges, "to put to rest any claim that administrative proceedings pending before, or presided over by, commission administrative law judges violate the appointments clause."

The SEC also directed administrative law judges presiding over pending proceedings without initial decisions to reconsider those records and allow parties to submit any new evidence relevant to a re-examination of the record.

In addition to the five current SEC administrative law judges, the decision could affect thousands of other government in-house judges, depending on what happens when the case is remanded.

The Supreme Court did not address the related question of whether such judges can be terminated if they are constitutionally appointed under the Administrative Procedure Act, which would require legislation.

"The most interesting aspect of this decision going forward is that Lucia and other defendants who have open challenges to their ALJ decisions will receive new hearings, but before a different ALJ than the one that issued their decision. And if the SEC chooses an ALJ whose appointment was ratified by Nov. 30, 2017, those new proceedings could also be challenged because the Supreme Court did not decide the validity of that order," said attorney Jack Yoskowitz, partner at Seward & Kissel.

Attorney Ken Berg with Ulmer & Berne, who is representing a case similar to the client who prevailed on the constitutionality issue in the 10th Circuit, said the Supreme Court decision "leaves us in a good place. Now the next question is what about all those cases that didn't (challenge the SEC). If everything they did last November was not correct, they still have got problems with it." With the question of removing administrative law judges undecided, "the SEC is running potentially an even bigger risk of having every decision questioned every time," Mr. Berg said.