Disclosure: My law firm, Jones & Keller, PC; in particular my partner David Zisser, associate Krystyna Wamboldt, and assistant Kaydee Carson, represented the successful petitioner, David F. Bandimere.
January 23, 2017 – Administrative law judges, and administrative law courts, are nothing new. Many federal and state government agencies use “in-house” administrative law courts to adjudicate disputes or bring enforcement actions against bad-guys under their jurisdiction, including the Dept. of Agriculture, HUD, Interior, Labor, the EPA, and especially the Social Security Administration.
Before 2010 the Securities Exchange Commission could only seek administrative sanctions in enforcement actions in front of their in-house judges – for example, injunctions, cease and desist orders, and bars from future securities activity. That changed in 2010 when the Dodd-Frank Wall Street Reform and Consumer Protection Act expanded the penalties the SEC could seek through the use of in house courts, to include fines.
The foundation of the American judicial system is the burden of proof, which is on the prosecution – every defendant is presumed innocent until proven guilty. In criminal cases, the guilt must be proven beyond a reasonable doubt, in civil or administrative cases, the guilt or liability must be proven by a preponderance of the evidence or a similar standard. Statistical analysis alone suggests that in SEC in-house courts, every defendant is guilty – regardless of proof.
Since 2010, the prosecution success rate in SEC in-house courts is greater than 90%. From September 2013 to September 2014 the SEC won 100% of its administrative cases. Other courts with 100% conviction rates? North Korea, Medieval courts of inquisition, and kangaroo courts.
During the same time period, the SEC’s success rate in federal district court averaged around 62%.
There are several reasons the SEC has a nearly 100% success rate in its in-house courts, but one contributing factor is that the SEC in-house courts are unconstitutional. The SEC’s in-house law judges are employed by, and answer only to, the SEC. The SEC judges are hired by the SEC’s Chief administrative law judge, through an Office of Personnel Management selection process. They are hired for life (a ‘career appointment’), and can only be removed for cause. When judges work for the prosecutors, you get greater than 90% success rates. The Appointments Clause of the U.S. Constitution says:
The President shall nominate, and by and with the Advice and Consent of the Senate, shall appoint Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, and all other Officers of the United States whose Appointments are not herein otherwise provided for, and which shall be established by Law: but Congress may by Law vest the Appointment of such inferior Officers as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.
For example, federal judges are appointed by the President and approved by the Senate so that they answer to the people. As the court in Bandimere observed:
In Federalist No. 76, Alexander Hamilton explained the Senate-approval requirement “would be an excellent check upon the spirit of favoritism in the President, and would tend greatly to prevent the appointment of unfit characters from Senate prejudice, from family connection, from personal attachment, or from a view to popularity.”
In Weiss v. United States, 510 U.S. 163 (1994) , the Supreme Court stated the Framers structured “an alternative appointment method for inferior officers” to promote “accountability and check government power: any decision to dispense with Presidential appointment and Senate confirmation is Congress’s to make, not the President’s, but Congress’s authority is limited to assigning the appointing power to the highly accountable President or the heads of federal departments, or, where appropriate, to the courts of law.”
In the vernacular of the Appointments Clause, “inferior officer” means an officer of the United States who has a superior. The hierarchy is superior officer, inferior officer, and employee. Employees are not subject to the Appointments Clause. Superior officers can only be appointed by the President with Senate approval, and inferior officers can be appointed by department heads, the courts or the president, if authorized by Congress.
As the SEC began bringing more cases in its in-house courts, and as a result attaining a nearly 100% success rate, lawyers began fighting back by challenging the constitutionality of these proceedings. On December 27, 2016 the Tenth Circuit Court of Appeals handed down its decision in Bandimere v. U.S. Securities Exchange Commission, No. 15-9586, 2016 WL 7439007 (10th Cir. Dec. 27, 2016), holding the SEC’s in-house court system unconstitutional, in violation of the Appointment Clause.
In a particularly well written and well-reasoned opinion and concurrence, the majority determined that the SEC administrative law judges are inferior officers of the United States, are subject to the Appointments Clause, and that the SEC’s hiring process for these judges is unconstitutional.
The SEC argued that its administrative law judges were mere employees and not subject to the Appointments Clause, and the SEC’s argument had prevailed in an earlier 2016 case in the D.C. Circuit, Raymond J. Lucia Cos. v. SEC (D.C. Cir. Aug. 9, 2016). Bandimere, who was an unwitting and unintentional participant in a Ponzi scheme and was found liable, sanctioned and fined by the SEC judge, certainly felt like the judge was an officer of the United States, and the Tenth Circuit Court agreed.
As a result, SEC in-house court decisions in the Tenth Circuit (Colorado, Kansas, Oklahoma, Utah, Wyoming, and New Mexico) are unconstitutional. SEC in-house court decisions in the D.C. Circuit and potentially other jurisdictions remain constitutional and enforceable for now. The discrepancy is likely to be finally settled by the Supreme Court.
The larger questions: will appointing the SEC judges in a constitutional manner make any difference? What happened to the fundamental principal that an accused is innocent until proven guilty?
The SEC’s administrative courts provide far fewer protections to defendants than the federal courts. In SEC proceedings, discovery (the ability of your lawyer to get her hands on all the relevant evidence) is very restricted, and the time frame for discovery is very short, leaving the defendant little time to prepare. There is no right to a jury. The proceedings are not subject to the Federal Rules of Evidence – a complicated set of rules designed to assure that only valid, reliable evidence can be presented. Without the Rules of Evidence, the SEC can admit hearsay and other unreliable evidence against the defendant. The SEC in-house system also precludes any meaningful appeal of a judge’s decision – appeal is only allowed to the SEC commissioners. If you lose there, then you can appeal to the federal circuit court in D.C. or in the district of the defendant’s residence, but that court grants deference to the SEC’s decision, rather than reviewing the case with fresh eyes. Worse, if the SEC judge finds for the defendant, the Commission can overturn that decision and find the defendant guilty!
In fact, the SEC Division of Enforcement cannot bring an enforcement action on its own. It must recommend the action to the Commission, who then authorizes the action. If your local government worked this way, the appeals court judges would hire the district court judges, the district attorney, the prosecutors and the police force. The police and prosecutors would investigate crimes but could not bring charges; they would make recommendations to the appeals court, who would order them to arrest someone and bring charges. Those charges would then be tried before the district court judge hired by the appeal court. If the defendant loses and files an appeal, the appeal would be heard by the same appellate judges who authorized the police and prosecutors to arrest the defendant in the first place.
Rather than keeping the three fundamental branches of government separate as required by the Constitution, the SEC system combines the judiciary with the executive, completely circumventing the requirement of an independent, accountable judiciary. As the court in Bandimere observed, “The structural interests protected by the Appointments Clause are not those of any one branch of Government but of the entire Republic.”
When the SEC does not have a strong enough case for the DOJ to bring criminal charges, or even to bring a civil action in federal district court, they can instead bring a case before their own in-house judges with evidence that would not support a real court case. If the SEC can’t put you in jail, they will just take all your money.
Since the Bandimere decision, the SEC continues to reject challenges to the constitutionality of its in-house courts. On January 6, 2017 the Commission entirely ignored the Tenth Circuit’s Bandimere decision in In the Matter of Harding Advisory LLC and Wing F Chau while rejecting the Appointments Clause argument: “We have rejected similar claims before and against do so here. Recently, the D.C. Circuit confirmed in Raymond J. Lucia Company v. SEC that out ALJs are employee, not constitutional Officers, and thus their manner of appointment is not subject to the requirements of the Appointment Clause.”
On January 13, 2017 in In the Matter of Alexander Kon the SEC judge rejected a motion from Kon to disqualify the judge based on the Bandimere decision, even though Kon’s case is in the Tenth Circuit, stating: “The Commission has made clear that it finds no merit to the contention that its administrative law judges should have been appointed in a manner consistent with the Appointments Clause…Bandimere notwithstanding.” In other words, according to this judge the Commission intends to ignore the Tenth Circuit Court of Appeals, signaling the SEC’s intent to practice nonacquiesence, an infamous practice of the IRS.
The Bandimere decision, if upheld, will require that SEC in-house judges be appointed through the constitutional process, but does nothing to change the fact that Congress authorized the SEC to bring actions and impose fines against individuals in an administrative court system that denies defendants the rights, protections, and procedures that American’s believe are the foundation of the U.S. judicial system and “due process” under the Constitution. The outcomes of that process are predictable and historically proven.
According to Bandimere’s lawyer, David Zisser: “I am zero for my lifetime defending SEC cases at the administrative level; I’ve never won. In cases in U.S. District Court, I have gotten complete defense verdicts probably two-thirds of the time, where I’ve taken them completely through trial. That doesn’t necessarily prove anything, but I don’t think I turn into a worse lawyer in an administrative case than in federal district court,” said Zisser. “The Washington Generals have a better record against the Harlem Globetrotters than I have against the SEC in administrative cases.”
Platt, Alexander: SEC Administrative Proceedings: Backlash and Reform
Denver Post: SEC decisions in danger
Washington Post: Are the SEC’s administrative law judges unconstitutional?
Wall Street Journal: SEC’s Use of In-House Courts Unconstitutional, Appeals Court Rules