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Storm at SEC Over Appointments Clause Violations Concerning its ALJs and Possible Implications as to Circular 230 ALJs, Part I

Posted on Sep. 3, 2015

We welcome back frequent guest blogger Carl Smith who looks at litigation taking place in non-tax sector of the federal government concerning Administrative Law Judges that could have some impact on the tax world. The IRS does not use administrative law judges very often. The case involving National Taxpayer Advocate Nina Olson and whether it was appropriate for the Commissioner to place her on furlough during the last government shutdown is one in which an ALJ ruled on a matter involving the IRS. This is the first of a two part post. Keith

A storm brewing since 2011 at the SEC over its ALJs has finally broken, with two district courts ruling this summer that the ALJs there had to be, but some were not, properly appointed under the Constitution’s Appointments Clause, Art. II, sec. 2, cl. 2. The court opinions are at Duka v. SEC, 2015 U.S. Dist. LEXIS 100999 (S.D.N.Y. Aug. 3, 2015), and Hill v. SEC, 2015 U.S. Dist. LEXIS 74822 (N.D. Ga. Jun. 8, 2015), and have generated a lot of discussion among Big Law corporate departments and a lot of reporting in the legal press.

The argument in the SEC cases derives from Freytag v. Commissioner, 501 U.S. 868 (1991), in which the Supreme Court held that Tax Court Special Trial Judges were inferior officers of the United States who both needed to be appointed under the Appointments Clause and were properly appointed under it because Congress had permissibly delegated appointment power to the Tax Court Chief Judge, since the Tax Court was one of “the Courts of Law”, within the meaning of the Clause. In Duka and Hill, the district courts, citing Freytag, ruled that SEC ALJs were also inferior officers who had to be appointed under the Clause, but the SEC – which was a “Department” of which the Commissioners were “Heads” under the Clause – had never properly appointed the ALJs at issue. Even though the SEC could tomorrow easily appoint such ALJs, to date, it has refused to do so – worrying, no doubt, that recently-tried ALJ cases on review might have to be completely retried.

In this first part of a two-part post, I wanted to describe the holdings of the Duka and Hill courts. In the second part, I will discuss how ALJs at Treasury who hold hearings concerning Circular 230 violations compare to SEC ALJs and whether there might be problems concerning the appointment (if required) of the ALJs that Treasury uses. Teaser: Treasury doesn’t actually have any of its own ALJs. It borrows ALJs from other agencies (currently, the Department of Agriculture) under contracts with the other agencies.

SEC ALJs — Background

Merely from reading the SEC cases (no previous expertise in this area), I learned that, prior to Dodd-Frank, SEC enforcement actions were done by the SEC bringing suit in district courts. Dodd-Frank created an additional, alternative system for trying enforcement actions (including fines) through a new set of ALJs. The SEC enforcement people now can bring an action in these new ALJ tribunals, and any appeals from ALJ rulings first go to the SEC as a whole. A person who loses before the whole SEC can appeal directly to a Circuit Court of Appeals. The SEC reviews the rulings of the ALJ under a de novo standard, though it accepts the ALJ’s credibility findings, unless there is overwhelming evidence to the contrary.

Apparently, the SEC’s Commissioners have appointed some of the ALJs, but others currently being used at the SEC are merely hired by the SEC’s Office of Administrative Law Judges, with input from the Chief Administrative Law Judge, human resource functions, and the Office of Personnel Management (OPM). Indeed, the system in the federal government generally is that OPM qualifies all ALJs used by agencies. See 5 CFR § 930.204 (“An agency may appoint an individual to an administrative law judge position only with prior approval of OPM, except when it makes its selection from the list of eligibles provided by OPM.”).

Appointments Clause

The Appointments Clause was a response to complaints about “Offices” and “Officers” made in the Declaration of Independence. There, the Continental Congress wrote that King George III had “erected a multitude of New Offices, and sent hither swarms of Officers to harass our people, and eat out their substance.”

To provide for a check on too many officers, the drafters of the Constitution wanted to make sure that offices (beyond those mentioned in the Constitution) were henceforth created both by the legislature and the President, through enacted laws. The drafters also generally wanted the President and Congress be politically accountable for appointing good or bad officers. That’s why so-called “principal officers” under the Appointments Clause, such as Article III judges, must be appointed by the President with the advice and consent of the Senate.

The Constitution’s drafters realized that the government was likely to grow, and that there would be some other important government officers as to whom it would be impracticable for Congress to spend time on nominations. So, it was decided that as to “inferior officers” – usually, officers who report to higher officers (e.g., reporting to principal officers, like Cabinet secretaries) – Congress could give up its advice and consent power, but the delegation of appointment of such inferior officers was still limited to very high government actors who could be called to political account. The so-called “excepting clause” of the Appointments Clause allows Congress and the President to enact a law delegating the appointment of “inferior Officers”, but only to “the President alone, . . . the Courts of Law, or . . . the Heads of Departments”. An example of an inferior officer is the National Taxpayer Advocate, who, by statute, is allowed to be appointed, without Congressional involvement, by the Treasury Secretary. IRC § 7803(c)(1)(B)(ii). Cabinet secretaries are considered “Heads of Departments”. The IRS Commissioner would not be; he is only an inferior officer within the Treasury Department.

Not all government workers are officers under the Appointments Clause. Most government workers are mere employees, who don’t need to be appointed by anyone, but who can simply be hired by low-level bureaucrats in agencies. There have only been a couple of dozen Supreme Court Appointments Clause opinions over the course of the existence of our country, and most of those have concerned whether a particular officer was a principal officer or an inferior officer. The few Supreme Court cases attempting to distinguish inferior officers from mere employees are generally considered a mess – many of them from the 19th Century being tautological (i.e., because Congress named a person in a statute as an officer, that person must be a constitutional officer). More recently, the Supreme Court has articulated a test for officers – requiring them to exercise “significant authority” on behalf of the United States. Basically, an officer must have discretion and have the ability to make rulings or administer important government issues.

Some readers may remember my case of Tucker v. Commissioner, 135 T.C. 114 (2010), affd. on different reasoning on Appointments Clause issue, 676 F.3d 1129 (D.C. Cir. 2012), cert. denied 133 S. Ct. 646 (2012). In Tucker, I argued that Appeals Settlement Officers and their Team Managers who took on the statutory duties to conduct and rule in Collection Due Process cases were inferior officers who needed to be appointed under the Clause. The D.C. Circuit held that these actors were not inferior officers because (1) as to collection matters, they did not decide sufficiently important issues and (2) that, although as to liability issues, they did make final rulings on important issues, they did not exercise much discretion because Appeals is under the control of Counsel. I know many of you may laugh about at least the factual correctness of the latter holding (I did), but without a Circuit split, the Supreme Court would not review those holdings.

Freytag v. Commissioner

Anyway, in Freytag, a preliminary issue that the Supreme Court had to face was whether Tax Court Special Trial Judges (STJs) were inferior officers under the Appointments Clause or mere employees. Both the majority and concurring Justices all agreed that the STJs were inferior officers. In the section of the majority opinion deciding this issue, the Court applied the test of exercising significant authority and held that, because of the various Article III judge-like duties and the discretion exercised by STJs in ruling on important tax liability issues, the STJs were inferior officers. Seemingly only after so concluding, the Court also pointed out that STJs can in some cases (see IRC § 7443A(c)) even make the final decision of the Tax Court. 501 U.S. at 880-82.

In passing, Justice Scalia’s concurrence in Freytag (joined by Justice Kennedy and two other Justices no longer sitting) discussed ALJs in government agencies generally. Scalia wrote: “Today, the Federal Government has a corps of administrative law judges numbering more than 1,000, whose principal statutory function is the conduct of adjudication under the Administrative Procedure Act (APA), see 5 U.S.C. §§ 554, 3105. They are all executive officers.” 501 U.S. at 910 (emphasis in original). One of the U.S. Code sections cited by Justice Scalia was 5 U.S.C. § 3105, which provides: “Each agency shall appoint as many administrative law judges as are necessary for proceedings required to be conducted in accordance with sections 556 and 557 of this title [i.e., adjudication].” This is the statutory provision commonly cited for Congress, under the Appointments Clause, having delegated power to Cabinet Secretaries to appoint ALJs without the Senate’s advice and consent.

Landry v. FDIC

Despite what Justice Scalia said in 1991 in Freytag, in Landry v. FDIC, 204 F.3d 1125 (D.C. Cir. 2000), a 3-judge panel of the D.C. Circuit held that certain ALJs at the FDIC were not officers of the United States who needed to be appointed under the Appointments Clause. There, Landry argued that Congress’ instruction to the banking agencies to “establish their own pool of administrative law judges” to conduct such hearings, see Federal Institutions [9]  Reform, Recovery, and Enforcement Act (“FIRREA”), § 916, 103 Stat. at 486, codified at 12 U.S.C. § 1818 note, would be unconstitutional because it vests appointment authority in a set of agencies that are not “Departments” under the Appointments Clause. Landry, 204 F.3d at 1130. The FDIC’s ALJ in the case was hired by the Office of Thrift Supervision and assigned to the case by the Office of Financial Institution Adjudication. In the D.C. Circuit, the FDIC abandoned the claim that this was proper appointment by the “Head[]” of a “Department”, but argued that the STJ was a mere employee, who need not be appointed.

The D.C. Circuit found that the FDIC ALJs were in many ways like the Tax Court STJs, since the ALJs were established by law; their duties, salary, and means of appointment were specified by statute; and they conduct trials, take testimony, rule on evidence admissibility, and enforce discovery compliance. Landry, 204 F.3d at 1133-34. And the Landry majority recognized that Freytag found that those powers constituted the exercise of “significant discretion”.

Despite these similarities, the Landry majority interpreted Freytag to hold that whether the actor in question had the authority to render a final decision was a dispositive factor. According to the majority, Freytag “noted that (1) STJs have the authority to render the final decision of the Tax Court in declaratory judgment proceedings and in certain small-amount tax cases,” and (2) the Tax Court was required to defer to the STJ’s factual and credibility findings unless they were clearly erroneous. While recognizing that the Freytag court “introduced mention of the STJ’s power to render final decisions with something of a shrug,” Landry held that FDIC ALJ’s were not inferior officers because they were reviewed de novo on both the facts and the law and did not have the power of entering final decision in certain classes of cases. Landry, 204 F.3d at 1133-34.

A concurring judge in Landry, Judge Randolph, who disagreed with the majority’s Appointments Clause reasoning, instead found no material relevant differences between the FDIC ALJs and the Tax Court STJs. Both, he felt, were inferior officers. After arguing that the Supreme Court actually found the Tax Court’s deference to the STJ’s credibility findings was irrelevant in its Freytag analysis, Judge Randolph also contended that the Landry majority’s holding that relied on the FDIC ALJ’s lack of final order authority was based on an unnecessary alternative holding from Freytag, as the Supreme Court had already determined the STJs were inferior officers before it mentioned the final order authority powers. Id. at 1140-42 (Randolph, J.). Judge Randolph said that he didn’t need to look to this alternative finality holding before he had to conclude that the FDIC ALJs were inferior officers.

Free Enterprise Fund v. PCAOB

Ten years after Landry, the Supreme Court decided its most recent Appointments Clause case. In Free Enterprise Fund v. PCAOB, 561 U.S. 477 (2010), the Court faced both Appointments Clause and removal power issues concerning the Public Companies Accounting Oversight Board (PCAOB). Under the Appointments Clause, the Court found no problem in Congress’ having given the SEC the power to appoint the members of the PCAOB – after the Court first found unconstitutional, and struck on separation of powers grounds, for cause restrictions limiting the SEC’s removal power over PCAOB members. Making the PCAOB members subject to at will removal rendered them inferior officers under the Appointments Clause. Free Enterprise Fund also answered a question left open in Freytag, holding that an independent agency like the SEC could be a “Department” under the Clause. The Court also held that, collectively, a Commission of multiple members, like the SEC, could constitute the “Head[]” of the Department, under the Clause, so could constitutionally be authorized to appoint inferior officers. Id. at 510-13.

In Free Enterprise Fund, Justice Breyer (joined in his dissent by Justices Stevens, Ginsburg, and Sotomayor) wrote: “According to data provided by the Office of Personnel Management . . .  [128] there are 1,584 ALJs in the Federal Government. Each of these ALJs is an inferior officer.” 561 U.S. at 586. This prompted a responding footnote in the Court’s majority opinion noting Landry and observing: “Whether administrative law judges are necessarily ‘Officers of the United States’ is disputed.” 561 U.S. 507 n.10.

Duka and Hill Rulings

Hill was the first of the two district courts to rule that the SEC ALJs involved in the cases before them had not been appointed by the SEC, but had to be under the Appointments Clause. Hill contains the most thorough analysis of the Supreme Court Appointments Clause authority. Duka‘s opinion condenses the Hill ruling – adopting its reasoning entirely. In Hill, the district court judge found no significant differences between the SEC ALJs and either the STJs in Freytag or the FDIC ALJs in Landry. While noting that both the SEC and FDIC ALJs were subject to de novo review on factual findings – unlike Tax Court STJs, who were subject to deferential review – Hill and Duka read Freytag not to have turned on the scope of review of the STJs or whether the STJs could enter final judgments. Hill and Duka explicitly rejected the reading of Freytag by the Landry majority and accepted the reading of Freytag set out in the Landry partial concurring opinion of Judge Randolph. Since neither Hill nor Duka is appealable to the D.C. Circuit, these cases could end up triggering a Circuit split over what the Supreme Court meant in Freytag – one that the Supreme Court will have to resolve.

In Part II of this post, I will do a comparison of the ALJs that the Treasury uses in Circular 230 enforcement matters with the FDIC and SEC ALJs. I will also explore whether there are other potential problems, either statutory or under the Appointments Clause, with the Treasury-used ALJs. The second part of this post will be of particular interest to anyone who had recently unsuccessfully represented a practitioner before such an ALJ on a Circular 230 matter.

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