Friday, September 01, 2023

Government files merits brief in SEC ALJ case

By Mark S. Nelson, J.D.

The Solicitor General, on behalf of the SEC, has filed its merits brief in a case posing multiple, potentially existential questions for the SEC’s in-house administrative proceedings, which have already been significantly impacted by an earlier Supreme Court decision finding that SEC administrative law judges (ALJs) are officers of the U.S. The most recent case raises questions about the Seventh Amendment right to a jury trial, the nondelegation doctrine limiting the authorities that Congress can grant to other branches of the federal government, and raising questions about how SEC ALJ’s can be removed from office. While the government urged the justices to reverse the Fifth Circuit’s decision against the SEC in its entirety, portions of the government’s merits brief suggest the possibility of a split decision from the justices (SEC v. Jarkesy, August 28, 2023).

Seventh Amendment. The government’s merits brief first addressed whether the Seventh Amendment requires that SEC administrative respondents have the right to a jury trial. The government argued that, under Article III, the public rights doctrine allows Congress to empower agencies to decide if someone has violated a Congressionally-created statutory obligation. From the government’s view, the presence of a choice to use the federal courts or in-house courts to enforce the federal securities laws should not negate Congress’s decision to allow that choice.

The government also said the Fifth Circuit had misread key Supreme Court precedents that, in its view, are dispositive of the SEC respondent’s appeal. The government also went on to note that the Seventh Amendment applies to suits at common law that involve a dispute meeting the jurisdiction amount and that SEC enforcement actions are not suits at common law. In other words, Congress created “new statutory obligations” to promote, among other things, disclosure and investor protection, while also permitting the SEC to act in the public interest regarding harm to the public at large. As a result, when the SEC chooses a federal court forum, the right to a jury trial applies, but that is not the case, the government said, regarding in-house proceedings.

Nondelegation doctrine. With respect to the second question presented, the government argued that Congress had not violated the nondelegation doctrine by giving the SEC a choice of pursuing enforcement cases in federal courts or in in-house proceedings or, not bringing an enforcement case in the first place. According to the government, whether and where to bring an enforcement case are quintessential executive powers rooted in the Constitution’s Article II Take Care clause.

The Fifth Circuit, said the government, misunderstood what constitutes legislative power. For example, the government said that the lower court had emphasized “categories” of cases instead of properly focusing on executive power regarding individual cases. The government added that the nondelegation doctrine is more of a problem where Congress has authorized an agency to adopt general rules for private conduct.

Removal. In a portion of its brief, the government addressed the question of tenure protection for SEC ALJs. This is the question that former Justice Breyer, who concurred in part and dissented in part in Lucia (holding SEC ALJs are officers of the U.S.), said needed to be answered before he could reach the Constitutional questions about the status of the SEC’s ALJs.

The government, as it must, conceded that the SEC’s ALJs are inferior officers per Lucia, but disputes that such officers cannot also enjoy multiple layers of tenure protection against removal. Central to the government’s theory is the notion that a different removal approach applies depending on whether an officer is a “policymaker[]” or an “adjudicator[].” In the latter case, the government posited that tenure protections ensure a degree of independence from the agency’s leaders, in this case the Commission. “Because adjudicators have a distinctive need for decisional independence, Congress has more leeway to grant tenure protection to them than to other executive officers,” said the government.

Much of the government’s tenure argument flows from the open questions left by the Supreme Court in Free Enterprise, the case in which a majority of the justices stripped PCAOB board members of their dual tenure protections so that the president, via the Commission, can more directly hold PCAOB board members accountable. Generally, the government explained, Congress can vest appointment of inferior officers in department heads and limit the removal of those inferior officers. In essence, the government explained, one could look at how various powers are incidental to each other; for example: (1) the power to remove is part of the power to appoint; and (2) the power of congress to regulate removal is part of the power to vest appointments. From the government’s view, Free Enterprise did not establish a categorical rule against tenure protection, even if the later Lucia case demonstrates how removal and appointment tend to “overlap.” The government would have the justices confirm that the Court’s precedent and the Constitution allow for differing conclusions regarding appointment and removal.

The government cited three main reasons why SEC ALJs can seemingly enjoy multiple layers of tenure protection. First, the government said the SEC’s ALJs adjudicate discrete, individual cases and Congress could determine that these ALJs need a degree of independence from the Commission in order to bolster the fairness of administrative proceedings at the SEC.

Yet another reason for affording SEC ALJs tenure protection flows from the Administrative Procedure Act, which the government said contains enough tools for the president and the Commission to control any exercise of executive authority by SEC ALJs. Overall, the basis for this conclusion is that the Commission is not bound by any decision of an SEC ALJ, although several arguments support this general conclusion. First, the government noted that the Commission can preside instead of an ALJ, or the Commission can assign one or more of its members to preside over an in-house case. Second, ALJ tasks, which the Court in Lucia described as judge-like for purposes of officer status, remain subject to SEC rules for administrative proceedings. Third, the Commission can reserve the initial decisions typically issued by an ALJ to itself. Lastly, the government said ALJ decisions are appealable to the Commission and the Commission also can take up such an appeal on its own motion.

Moreover, the government argued that the removal standard that justices found Constitutionally infirm in Free Enterprise is a much more difficult standard to meet than the standard applicable to the SEC’s ALJs. In Free Enterprise, the Sarbanes-Oxley Act referred to another statute for the standard for removing PCAOB board members; that statute focused on willful conduct and, at least on its surface, suggested it would be difficult to remove PCAOB board members. By contrast, the government said the “good cause” standard applicable to the SEC’s ALJs under 5 U.S.C. §7521 is much less onerous to meet.

The government also posited that the hearing before the U.S. Merit Systems Protection Board (MSPB) required by 5 U.S.C. §7521 is constitutionally appropriate. The government cautioned that a finding that 5 U.S.C. §7521 is unconstitutional would upend Congressional efforts to ensure the fairness of administrative proceedings.

Split decision? Perhaps hinting at the potential for a split decision from the justices, the government closed its merits brief by arguing that if the Court were to find 5 U.S.C. §7521 unconstitutional as applied to the SEC’s ALJs, while also siding with the government on the Seventh Amendment and nondelegation doctrine questions, the Court should, because of the nature of the Fifth Circuit’s disposition of the case, remand the removal question to the Fifth Circuit so the lower court can determine if the SEC respondents were prejudiced by the limit on removal of the SEC’s ALJs. But, said the government, if the Court were to find for the SEC respondents on the Seventh Amendment or nondelegation doctrine questions, then vacatur of the Commission’s final order would be the proper disposition of the case. Nevertheless, the government also reiterated its view that the Fifth Circuit’s opinion should be reversed in its entirety.

The case is No. 22-859.