Adventures in the Fourth Branch of Government

Robert Jackson, a Supreme Court Justice and the lead prosecutor at the Nuremberg war crimes trials, once said that the rise of administrative agencies had been the last century’s “most significant legal trend,” they had “become a veritable fourth branch of the Government, which has deranged our three-branch legal theories much as the concept of a fourth dimension unsettles our three-dimensional thinking.”1

That was in 1952, and Justice Jackson was talking about the takeover of lawmaking by administrative bodies, what lawyers refer to as their quasi-legislative function. Imagine his reaction today. The Code of Federal Regulations, where administrative regulations are codified, consisted of 22,877 pages in 1960. By 2012, it had grown to 174,545 pages. According to the Congressional Research Service, the number of final rules published each year is in the range of 2,500 to 4,500.

The other principal function of administrative bodies is quasi-judicial: adjudicating the rights of corporations and persons in trial-type proceedings. Charles L. Hill, Jr. learned about the tendency of agencies to supplant the courts when he became the subject of an investigation of nearly two years by the Securities and Exchange Commission. Hill had never registered with the SEC, but had come to its attention when he purchased and sold a large quantity of Radiant Systems, Inc. stock in June and July of 2011, making a profit of approximately $744,000. The SEC alleged that Hill was able to turn the profit because of inside information he had about a future merger between Radiant and NCR Corporation.

As a result of two developments, one legislative, the other administrative, the SEC brought a regulatory lawsuit against Hill before one of its in-house administrative law judges, not in a federal court, where insider trading cases are customarily heard.

Prior to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC could not seek civil penalties from an unregistered person like Hill in an administrative proceeding. Dodd-Frank authorized the agency to proceed against “any person,”2 including those who had never registered with the SEC, in an administrative hearing.

The administrative development arose in 2013 when Andrew J. Ceresney, the SEC’s enforcement director, announced the agency’s plans to bring more regulatory lawsuits before its own administrative law judges. In the past, the SEC had steered mainly straightforward matters, such as actions to bar brokers convicted of crimes, to its in-house hearing officers.

The SEC still brings the majority of its cases in federal court, 63% this fiscal year to date—but the expansion of its regulatory jurisdiction has caused considerable controversy, drawing critical backlash from lawyers and in the press. This, based on the perception that the SEC will enjoy an advantage with its own judges. The evidence on this is mixed. Since 2012, the agency has succeeded in 93% of the matters heard by its own judges, while its success rate in federal courts has been 77%. These data say nothing about the types or complexity of the cases, so it’s hard to say whether the perception matches the reality.

But whether or not the SEC’s administrative mechanism is the star chamber critics claim it is, the SEC certainly has an advantage when it can investigate a case for years and then bring the matter quickly to hearing. In fact, once the SEC serves its order instituting proceedings, it has approximately four months to commence the hearing.3 In the process, SEC targets are denied unquestionably valuable procedural protections such as a jury trial, full pretrial discovery and the right to make counterclaims, and the SEC is not subject to the Federal Rules of Evidence at the hearing.

Which brings us back to Charles Hill. Rather than submit to a proceeding before one of the SEC’s internal judges, he instituted a suit in federal court in Georgia to bar the SEC from proceeding with an administrative hearing on June 15, 2015.4 Hill raised a number of claims against the SEC, one of them based upon Article II, Section 2, Clause 2 of the United States Constitution.

Known as the Appointments Clause, that relatively obscure section of Article II creates two classes of officers: principal officers nominated by the President with the advice and consent of the Senate (such as Ambassadors and Supreme Court Justices) and inferior officers, whom “Congress may allow to be appointed by the President alone, by the heads of departments, or by the judiciary.”5 Thus, the Constitution governs officers, who have presidential, judicial and department head appointments. They are subject to the Appointments Clause. All other federal employees are not.

SEC administrative law judges were appointed through the Offices of Personnel Management, not by the President, the SEC or the judiciary, and are subject to the civil service system. So the issue Hill raised was whether they were inferior officers within the meaning of the Appointments Clause, or merely employees of the SEC, who did not fall under Article II.

The role of the SEC’s internal judges is to take testimony, conduct hearings, rule on the admissibility of evidence and make recommendations to the SEC. They do not have contempt power and cannot issue final orders, powers reserved for the SEC. These last two powers had been important in previous Appointments Clause cases. Nevertheless, the federal judge in Hill’s case found that the administrative hearing officer was not appropriately appointed pursuant to Article II and that the appointment was likely unconstitutional in violation of the Appointments Clause. He therefore prohibited the SEC from conducting the administrative proceeding.

The case at first glance seems to put a serious crimp in the SEC’s plans to bring more regulatory lawsuits before its in-house judges. As legal authority, however, the case might not be enduring. First, it doesn’t bind any other federal judge. Second, the decision is based on thin precedent. And perhaps most important of all, the SEC can easily cure the defect. SEC Commissioners jointly constitute the “department head” of the SEC for appointment purposes. The Commissioners can simply reappoint all of the administrative judges themselves, which would meet Hill’s objection.

What the case does represent is an expression of dissent by one judge about what he evidently views as a case of administrative overreach. Whether this decision and the widespread criticism the SEC’s policy has generated will cause the agency to rethink its decision to steer more cases, and more complex cases, to its administrative judges remains to be seen.

Endnotes

1 FTC v. Ruberoid Co., 343 U.S. 470, 487 (1952) (Jackson, J., dissenting).

2 15 U.S.C. § 78u-2.

3 17 C.F.R.§ 201.360(a)(2).

4 Hill v. Securities and Exchange Commission, Civil Action No. 1:15-CV-1801-LMM (N.D.Ga. June 8, 2015).

5 Buckley v. Valeo, 424 U.S. 1, 132 (1976).