By Mark S. Nelson, J.D.
In a pre-Labor Day weekend surprise, the Commission issued a final order upholding penalties imposed against an investment adviser and found that a constitutional issue that has dogged the agency’s administrative law judge regime in federal court’s since last year had no bearing on the outcome of the case. On this latter point, a bare three-commissioner majority said Article II of the U.S. Constitution did not apply to its “employee” ALJs. A separate dissent from Commissioners Daniel M. Gallagher and Michael S. Piwowar still has not been made public (In the Matter of Raymond J. Lucia Companies, Inc., Release No. 34-75837, September 3, 2015).
The ALJ claim. The SEC brought an administrative proceeding against Raymond J. Lucia Companies, Inc. and its owner Raymond J. Lucia for violations of the Investment Advisers Act, which an ALJ largely upheld in an initial decision. But when it came to RJL companies’ claim that the agency proceeding against it was unconstitutional because the SEC’s ALJs were not properly appointed under Article II, the Commission said not so fast.
The Commission reasoned by analogy to the D.C. Circuit’s opinion in Landry v. FDIC, in which that court held the Federal Deposit Insurance Corporation’s ALJs exercised discretion in carrying out their duties, but they were employees because final decision authority rested solely with the FDIC. Likewise, the Commission said its ALJs are merely “employees” and not “inferior officers,” who must be appointed by either the president, heads of departments, or courts of law.
The Commission said no one disputed that the ALJ in the RJL Companies case (Cameron Elliot) was not appointed in this manner. A footnote to this section also observed that the Supreme Court had previously said the SEC is the head of a department for purposes of Article II, at least when the commissioners act collectively.
The Commission also distinguished its ALJs from the Tax Court’s special trial judges that the Supreme Court in Freytag held to be inferior officers because they exercised wide discretion and sometimes could be final. The Commission again emphasized that its ALJs’ initial decisions do not become final without Commission action. To further dispel the notion of ALJ finality, the Commission said its practice is to grant most petitions for review of initial decisions, and the Commission can act on its own to review a matter if no petition is filed.
One might ask how this Commission decision may impact the several federal court suits disputing the SEC’s ALJs? Although one can find subtle differences in a few of the leading cases cited in briefs filed by the SEC and the challengers, the Supreme Court precedents largely stand for the rule that federal district courts can be barred from exercising subject matter jurisdiction over claims when it is fairly discernable that Congress intended to channel claims of a particular type through the administrative process before allowing judicial review, typically by an appeals court.
But that rule can break down if channeling cases in this way would deprive parties of all meaningful judicial review, the claims are wholly collateral to the statutory review provisions, and if the claims are beyond the agency’s expertise. The challengers in the court cases place great emphasis on these factors, discussed most recently by the Supreme Court in its Elgin and Free Enterprise decisions.
At the least, the Commission’s RJL Companies opinion implies that a majority of the commissioners believe the Article II question, as presented to it, was within the agency’s expertise. “It is important that the Commission have an opportunity to address constitutional issues in the first instance, as it has in the past,” the Commission said in footnote 94, while referencing its prior views on double jeopardy and the Seventh Amendment.
The Commission heard similar Article II arguments in another appeal of an initial decision (Timbervest) earlier this year, but the Commission has yet to issue a final opinion in that matter. Something to watch for in the next few days or weeks will be whether any of the parties in the active federal suits may wish deal with the RJL Companies opinion in supplemental court filings.
Advisers Act cross-appeals. The ALJ’s initial decision yielded a mixed result for RJL Companies and the SEC’s Enforcement Division. The Commission upheld the ALJ’s findings that the company misled investors about its “Buckets of money” investment strategy in violation of Advisers Act Sections 206(1), 206(2), and 206(4). Lucia was barred from associating with an investment adviser or broker-dealer, and both Lucia’s and RJL Companies’s adviser registrations were revoked with second-tier civil penalties of $250,000 imposed on the company, and $50,000 on Lucia.
The Enforcement Division cross-appealed its initial loss on its fraudulent advertisements claim under Advisers Act Rule 206(4)-1(a)(5). On appeal, the Commission upended the ALJ’s decision and instead ruled for the Enforcement Division because a slideshow put on by the respondents was a “written communication” and otherwise met the definition of “advertisement.” But the Enforcement Division let slip the chance to cross-appeal the ALJ’s finding that RJL Companies had not violated Advisers Act Section 204’s recordkeeping mandate.
The release is No. 34-75837.