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From Securities Regulation Daily, December 29, 2016

Tenth Circuit splits, determines SEC ALJs are unconstitutionally appointed ‘inferior officers’

By Amanda Maine, J.D.

A divided panel of the U.S. Court of Appeals for the Tenth Circuit has gone against other recent appellate court decisions siding with the SEC regarding its in-house administrative regime. The majority found that the SEC inappropriately determined the Commission’s administrative law judges (ALJs) were not "inferior officers" under the Constitution. According to the panel, the SEC, as well as other district and circuit courts, misinterpreted the Supreme Court’s decision in Freytag v. Commissioner of Internal Revenue (1991) because it concentrated on the lack of finality of the administrative court’s decision instead of the power an ALJ actually possesses (Bandimere v. SEC, December 27, 2016, Matheson, S.).

Administrative proceeding. The SEC brought an administrative proceeding against David F. Bandimere in 2013, alleging various securities fraud and registration charges. The ALJ’s initial decision found that Bandimere was liable for the violations and barred him from the securities industry, ordered him to cease and desist from violating securities laws, imposed civil penalties, and ordered disgorgement. Bandimere appealed to the circuit court, challenging the ALJ’s authority on the grounds that SEC ALJs are inferior officers, and that the ALJ in his case was appointed unconstitutionally under the Appointments Clause. This argument has been met with very little success in other circuits, with most deeming that they lack personal jurisdiction over SEC administrative proceedings that are ongoing under the statutorily approved regime.

Freytag.The Tenth Circuit panel, voting 2-1, broke with its appellate colleagues in ruling that SEC ALJs are inferior officers under the Constitution. Judge Matheson, writing for the majority, disagreed with other circuit courts’ conclusion that the Freytag case hinged on the "finality" of a decision in whether to deem an administrative judge an inferior officer or an employee.

In Freytag, the Supreme Court concluded that special tax judges (STJs) appointed by the Tax Court were inferior officers, and not employees. According to Judge Matheson, the SEC’s argument was based on the argument that ALJs, whose initial decisions can be appealed to the full Commission and then to the appellate court, cannot render final decisions. Judge Matheson advised that this was a misreading of Freytag. Instead, a test of whether a person is an inferior officer should be based on whether that person exercises a great deal of discretion and performs important functions. While final decision-making power is relevant to determining whether a public servant exercises "significant authority," the judge wrote, it does not mean that final decision making power is dispositive to deeming that the person is an "inferior officer" under the Constitution.

Dissent. Judge McKay dissented from the majority opinion. In addition to voicing his concern about the consequences of declaring ALJs inferior officers, which could "effectively render … invalid thousands of administrative actions," Judge McKay disagreed with the majority opinion that the STJs of the Tax Court in Freytag were analogous to the SEC’s ALJs. According to Judge McKay, the Tax Court was required to defer to the findings of the STJs. The Commission, hearing an appeal, is not limited by the record and may engage in fact-finding and hear additional evidence, unlike the STJs in Freytag, Judge McMay wrote.

The case is No. 15-9586.

Attorneys: David A. Zisser (Jones & Keller) for David F. Bandimere. Michael Andrew Conley for the SEC.

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