BREAKING NEWS: Federal Appeals Court Says Securities and Exchange Commission ALJs Unconstitutional
December 28, 2016
This Initial Decision finds that Respondent David F. Bandimere (Bandimere) willfully violated Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 (Securities Act) and Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 (Exchange Act) and Exchange Act Rule 10b-5. This Initial Decision bars Bandimere from association with a broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization (NRSRO), orders Bandimere to disgorge $638,056.33 plus prejudgment interest, imposes a civil penalty of $390,000, and orders Bandimere to cease and desist from committing or causing violations of the above-listed provisions of the Securities and Exchange Acts.
The charges in this matter are based on Bandimere's involvement in selling investments in IV Capital LTD ("IVC") and Universal Consulting Resources LLC ("UCR"). Having received some funds from the sale of a family business, Bandimere mentioned to Richard Dalton, a friend of many years, that he was looking for a place to invest the money and would like to know if Dalton had heard of anything promising. Dalton told Bandimere that he had brought together some investors who were investing with Larry Michael Parrish, a principal of IVC, and that he was getting paid for handling distribution of checks and other tasks for Parrish. In late 2005, Bandimere began investing with Parrish, and by the middle of 2006, he began arranging for others to invest in IVC through his personal account, receiving fees from IVC based on their investments in compensation for his efforts. In 2007, working with an attorney who also had invested in IVC (and later in UCR), Bandimere formed limited liability companies through which people could invest in IVC, continuing to receive fees on a monthly basis based on the amounts they invested. Also in 2007, Dalton set up an investment vehicle of his own, UCR, and Bandimere began arranging for people to invest in it, also through the LLCs. As was the case with IVC, Bandimere received payments from UCR on a monthly basis based on the amounts people invested in UCR through him.Although the OIP did not allege that Bandimere knew so at the time of his alleged misconduct, both IVC and UCR turned out to be Ponzi schemes, run by Parrish and Dalton respectively. Both men were charged with operating a Ponzi scheme and violating securities registration, antifraud, and broker-dealer registration provisions of the securities laws, and judgment was ultimately entered against both men in separate actions in federal district court. In those proceedings, Parrish and Dalton were permanently enjoined and ordered to disgorge millions of dollars in ill-gotten gains and to pay an equal amount in civil penalties.But this case is not about whether Bandimere was the perpetrator of a Ponzi scheme, nor does it turn on whether Bandimere had actual knowledge that IVC and UCR were Ponzi schemes. This case is about whether Bandimere (1) sold securities for which no registration statement was in effect (and no exemption from registration applied), (2) operated as an unregistered broker, and (3) fraudulently omitted from the representations he made to investors material information about IVC and UCR that he, in fact, did know-regardless of the fact that they were Ponzi schemes. For the reasons explained below, we find that Bandimere violated Section 5 of the Securities Act by offering and selling unregistered securities, violated Section 15 of the Exchange Act by acting as unregistered broker, and violated antifraud provisions of the Securities Act and Exchange Act by failing to disclose material information that was necessary to make his representations to investors not misleading.
[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 the 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.
When the Framers drafted the Appointments Clause of the United States Constitution in 1787, the notion of administrative law judges ("ALJs") presiding at securities law enforcement hearings could not have been contemplated. Nor could an executive branch made up of more than 4 million people, most of them employees. Some of them are "Officers of the United States," including principal and inferior officers, who must be appointed under the Appointments Clause. U.S. Const. art. II, § 2, cl. 2. In this case we consider whether the five ALJs working for the Securities and Exchange Commission ("SEC") are employees or inferior officers.Based on Freytag v. Commissioner of Internal Revenue, 501 U.S. 868 (1991), we conclude the SEC ALJ who presided over an administrative enforcement action against Petitioner David Bandimere was an inferior officer. Because the SEC ALJ was not constitutionally appointed, he held his office in violation of the Appointments Clause Exercising jurisdiction under 15 U.S.C. §§ 77i(a) and 78y(a)(1), we grant Mr. Bandimere's petition for review.I. BACKGROUNDThe SEC is a federal agency with authority to bring enforcement actions for violations of federal securities laws. 15 U.S.C. §§ 77h-1, 78d, 78o, 78u-3. An enforcement action may be brought as a civil action in federal court or as an administrative action before an ALJ. In 2012, the SEC brought an administrative action against Mr. Bandimere, a Colorado businessman, alleging he violated various securities laws. An SEC ALJ presided over a trial-like hearing. The ALJ's initial decision concluded Mr. Bandimere was liable, barred him from the securities industry, ordered him to cease and desist from violating securities laws, imposed civil penalties, and ordered disgorgement. David F. Bandimere, SEC Release No. 507, 2013 WL 5553898, at *61-84 (ALJ Oct. 8, 2013).The SEC reviewed the initial decision and reached a similar result in a separate opinion. David F. Bandimere, SEC Release No. 9972, 2015 WL 6575665 (Oct. 29, 2015). During the SEC's review, the agency addressed Mr. Bandimere's argument that the ALJ was an inferior officer who had not been appointed under the Appointments Clause. Id. at *19. The SEC conceded the ALJ had not been constitutionally appointed, but rejected Mr. Bandimere's argument because, in its view, the ALJ was not an inferior officer. Id. at *19-21.Mr. Bandimere filed a petition for review with this court under 15 U.S.C. §§ 77i(a) - 4 - and 78y(a)(1), which allow an aggrieved party to obtain review of an SEC order in any circuit court where the party "resides or has his principal place of business." In his petition, Mr. Bandimere raised his Appointments Clause argument and challenged the SEC's conclusions regarding securities fraud liability and sanctions.
SIDE BAR: The 10Cir Opinion relies heavily upon Freytag v. Commissioner of Internal Revenue, 501 U.S. 868 (1991), which set forth the following in its preliminary "Syllabus":The Chief Judge of the United States Tax Court, an Article I court composed of 19 judges appointed by the President, is authorized to appoint special trial judges, 26 U.S.C. § 7443A(a), and to assign to them certain specified proceedings, §§ 7443A(b)(1), (2), and (3), and "any other proceeding which the chief judge may designate," § 7443A(b)(4). As to subsection (b)(4) proceedings, the special trial judge may hear the case and prepare proposed findings and an opinion, but the actual decision is rendered by a Tax Court judge, § 7443A(c). When petitioners sought review in the Tax Court of determinations of approximately $1.5 billion in federal income tax deficiencies, their cases were assigned to a Tax Court judge, but were later reassigned, with petitioners' consent, to a Special Trial Judge. His unfavorable opinion was adopted by the Chief Judge as the opinion of the Tax Court. The Court of Appeals affirmed, rejecting petitioners' arguments that the assignment of complex cases to a special trial judge was not authorized by § 7443A and that such assignment violated the Appointments Clause of the Constitution, which, inter alia, limits congressional discretion to vest the appointment of "inferior Officers" to the President, the heads of departments, and the courts of law.
Held:
1. Subsection (b)(4) authorizes the Chief Judge to assign any Tax Court proceeding, regardless of complexity or amount in controversy, to a special trial judge for hearing and preparation of proposed findings and a written opinion. Its plain language contains no limiting term restricting its reach to cases that are minor, simple, or narrow; and neither the statute's structure nor legislative history contradicts the broad sweep of this language. Pp. 501 U. S. 873-877.
2. Section 7443A does not transgress the structure of separation of powers embodied in the Appointments Clause. Pp. 501 U. S. 877-892.
(a) This is one of those rare cases in which the Court should exercise its discretion to hear petitioners' challenge. That challenge goes to the validity of the Tax Court proceeding that is the basis for this litigation and, thus, is a nonjurisdictional structural constitutional objection that
may be considered, even though petitioners consented to the assignment. See Glidden Co. v. Zdanok, 370 U. S. 530,370 U. S. 535-536. Pp. 501 U. S. 878-880.
(b) A special trial judge is an "inferior Office[r]" whose appointment must conform to the Appointments Clause. Such a judge acts as an inferior officer who exercises independent authority in cases governed by subsections (b)(1), (2), and (3). The fact that in subsection (b)(4) cases he performs duties that may be performed by an employee not subject to the Appointments Clause does not transform his status. Pp. 501 U. S. 880-882.
(c) The Clause reflects the Framers' conclusion that widely distributed appointment power subverts democratic government. Thus, such power can be vested in the Tax Court's Chief Judge only if that court falls within one of the three repositories the Clause specifies. Clearly Congress did not intend to grant the President the power to appoint special trial judges. And the term "Departmen[t]" refers only to executive divisions like Cabinet-level departments.United States v. Germaine, 99 U. S. 508, 99 U. S. 510-511. Treating the Tax Court as a "Department" would defy the purpose of the Clause, the meaning of the Constitution's text, and the clear intent of Congress to transform that court from an executive agency into an Article I court. Pp. 501 U. S. 882-888.
(d) An Article I court, which exercises judicial power, can be a "Cour[t] of Law" within the meaning of the Appointments Clause. The reference to "Courts of Law" cannot be limited to Article III courts merely because they are the only courts the Constitution mentions. Congress has wide discretion to assign the task of adjudication to legislative tribunals, see, e.g., 26 U. S. v. Canter, 1 Pet. 511, 26 U. S. 546; and an Article I court cannot exercise judicial power and not be one of the "Courts of Law." Buckley v. Valeo, 424 U. S. 1, distinguished. To hold otherwise would also undermine Congress' understanding that Article I courts can be given the power to appoint. See, e.g., 38 U. S. 13 Pet. 230. Pp. 501 U. S. 888-890.
(e) The Tax Court is a "Cour[t] of Law" within the Clause's meaning. It exercises judicial power to the exclusion of any other function; its function and role closely resemble those of the federal district courts; and it is independent of the Executive and Legislative Branches, in that its decisions are appealable in the same manner as those of the district courts. Pp. 501 U. S. 890-892.
904 F.2d 1011, affirmed.
Page 23 of the 10Cir OpinionThis holding serves the purposes of the Appointments Clause. The current ALJ hiring process whereby the OPM screens applicants, proposes three finalists to the SEC, and then leaves it to somebody at the agency to pick one, is a diffuse process that does not lend itself to the accountability that the Appointments Clause was written to secure. In other words, it is unclear where the appointment buck stops. The current hiring system would suffice under the Constitution if SEC ALJs were employees, but we hold under Freytag that they are inferior officers who must be appointed as the Constitution commands. As the Supreme Court said in Freytag, "The Appointments Clause prevents Congress from dispensing power too freely; it limits the universe of eligible recipients of the power to appoint." 501 U.S. at 880.
Page 30 of the 10Cir OpinionThe SEC further contends Congress intended its ALJs to be employees. It urges us to "accor[d] significant weight" to congressional intent in determining whether the ALJs are inferior officers. Aplee. Br. at 41.The SEC overstates its arguments. In its brief, it has not cited statutory language expressly stating ALJs are employees for purposes of the Appointments Clause. Nor has it cited legislative history indicating Congress has specifically addressed the question whether ALJs are inferior officers. And to the extent the SEC seeks to infer congressional intent from congressional action, the evidence is mixed.
ALJs "are more than mere aids" to the agency. Samuels, 930 F.2d at 986. They "perform more than ministerial tasks." Freytag, 501 U.S. at 881. The governing statutes and regulations give them duties comparable to the STJs' duties described in Freytag. SEC ALJs carry out "important functions," id. at 882, and "exercis[e] significant authority pursuant to the laws of the United States," Buckley, 424 U.S. at 126. The SEC's power to review its ALJs does not transform them into lesser functionaries. Rather, it shows the ALJs are inferior officers subordinate to the SEC commissioners. Edmond, 520 U.S. at 663.The SEC ALJ held his office unconstitutionally when he presided over Mr. Bandimere's hearing. We grant the petition for review and set aside the SEC's opinion.
I write not to differ with the rationale of the majority opinion, but rather to fully join it. My focus here is on the dissent. I group my concerns in two categories: (I) the dissent's predictions about speculative "repercussions" of the opinion, by which it reaches what appear to be several erroneous conclusions; and (II) its application of a truncated legal framework to a misstated version of the facts of record.
But that proviso is cold comfort to a defendant, like Mr. Bandimere, whose liability for massive civil penalties depends in no small part on the United States's assessment of his credibility during live testimony, credibility determined by the only government 10 employee designated to preside over that testimony-an ALJ. And whatever the SEC means by its disclaimer, it does not equate to de novo review. Rather, whether the SEC disagrees with its ALJs' credibility determinations triggers its own rule that an ALJ's evaluation of a witness's live testimony is entitled to "considerable weight." Id. at *15 n.83. Thus, at minimum, the SEC's ALJs exercise significant discretion over issues of credibility, unchecked by faux "de novo" review.
Finally, I began this dissent by expressing my fears of the probable consequences of today's decision. It does more than allow malefactors who have abused the financial system to escape responsibility. Under the majority's reading of Freytag, all federal ALJs are at risk of being declared inferior officers. Despite the majority's protestations, its holding is quite sweeping, and I worry that it has effectively rendered invalid thousands of administrative actions. Today's judgment is a quantitative one-it does not tell us how much authority is too much. It lists the duties of SEC ALJs, without telling us which, if any, were more important to its decision than others and why. And I worry that this approach, and the end result, leaves us with more questions than it answers.
Today's holding risks throwing much into disarray. Since the Administrative Procedures Act created the position of administrative law judge in 1946, the federal government has employed thousands of ALJs to help with the day-to-day functioning of the administrative state. Freytag, which was decided 25 years ago, has never before been extended by a circuit court to any ALJ. And yet, the majority is resolved to create a circuit split. When there are competing understandings of Supreme Court precedent, I would prefer the outcome that does the least mischief.
- "Split In The Circuits Widens As Jarkesy Challenges SEC" (BrokeAndBroker.com Blog, October 1, 2015)
- "BREAKING NEWS: 2nd Circuit Delivers Blow To Tilton Appeal" (BrokeAndBroker.com Blog, June 2, 2016)