Raymond J. Lucia – Compliance Building

Continuing Lucia

After last week’s Supreme Court decision in Lucia v. Securities and Exchange Commission, it’s clear that administrative law judges of the US Securities and Exchange Commission are not mere federal employees but qualify as “Officers of the United States” under the Appointments Clause of the US Constitution. That means they need be appointed by the president, courts of law, or heads of departments, in this case the SEC Commissioners.

It’s also clear that Mr. Lucia’s victory is hollow. The remedy in the decision was that Mr. Lucia was entitled to a new hearing by new administrative law judge who had been properly appointed. In December the SEC Commissioners ratified the appointment of the ALJs. That was done in anticipation of this decision. I assume that is enough to meet the requirements of the Appointments Clause. I expect that may also be challenged by Mr. Lucia if he case starts over.

There is still lots of uncertainty after the Lucia decision. Enough uncertainty that the SEC has halted all administrative proceedings for 30 days.

The Lucia decision required that the case be heard before a new ALJ. At a minimum, the SEC is going to do a lot of shuffling of cases from ALJ to another for any case started before December. It may also decide to shift the cases over to federal courts. According to one estimate there are 100+ cases involved.

One big unanswered question is whether the SEC ALJ proceedings are the proper venue. Dodd-Frank expanded the use of administrative proceedings. Under Chair White, the SEC increased its use of administrative proceedings instead of federal court. Under Chair Clayton, the SEC seems to be increasing using federal courts instead of the administrative proceedings. This was one of the points raised in Justice Breyer’s concurring opinion in Lucia.

I expect we will hear some news from the SEC during this 30-day halt on how they are going to proceed with ALJs.

Sources:

In re: Pending Administrative Proceedings imposing a temporary halt to administrative proceedings
SEC Order (33-10440, 34-82178, IA-4816, IC-32929) revising the ALJ process
The SEC’s Administrative Law Judges are “Officers of the United States”
Lucia: The Beginning of the End of SEC ALJs? by T. Gorman in SEC Actions
The Morning Risk Report: Ruling on SEC Judges Creates Uncertainty by Ben DiPietro
Supreme Court Tells SEC to Appoint ALJs (Even Though SEC Already Did) by Gregory Morvillo
Supreme Court Provides One Answer about SEC Administrative Law Judges, but Leaves Many Questions
Supreme Court Holds SEC’s Past Hiring of Administrative Judges Unconstitutional

The SEC’s Administrative Law Judges are “Officers of the United States”

The Supreme Court issued its decision in Lucia v. Securities and Exchange Commission. The problem is that the administrative law judges were appointed by an internal panel instead of by the President or the SEC Commissioners. The Appointments Clause of the Constitution is there to make sure that those who wield power are subject to “political force and the will of the people.” The President appoints “Officers” who are those who exercise “significant authority pursuant to the laws of the United States.”

Radio personality Raymond J. Lucia, Sr. got in trouble with the SEC by claiming that his “Buckets of Money” strategy had been successfully backtested when in fact it had not been. Lucia was a registered investment advisor, but the SEC barred him for his transgressions. He appealed.

The Supreme Court re-affirmed a three prong test to determine if an official is an “Officer” under the Appointments Clause:

Holds a continuing office established by law
Exercises significant discretion when carrying out the functions of that office
Issues decisions with finality

The majority opinion found all three of these to be true with the SEC’s ALJs.

The concurring opinion of Justices Thomas and Gorsuch though that the determination of an “officer” merely has to answer the first prong, proposing a much broader definition of an “officer.” The dissent by Justices Sotomayor and Ginsburg felt the finality part of the third prong was not true for the SEC’s ALJs because the SEC can overrule the decision.

What is the impact of the decision?

For Mr. Lucia, it means he is entitled to a new hearing with a different ALJ. The Supreme Court explicitly stated that Mr. Lucia is entitled to a new hearing with a different ALJ who is properly appointed.

I believe all of the SEC’s ALJs are now properly appointed directly by the SEC. In December, the SEC changed its process in anticipation of this decision. The Solicitor General had decided to agree with the argument of Mr. Lucia that the ALJs are “officers.”

The unanswered question is what happens to those cases decided by ALJs. I suppose there could be many others with adverse findings who are going to ask for new hearings with a different ALJ.

Sources:

SEC’s In-House Courts Are Upheld

There have been several challenges to the constitutionality of the in-house judges at the Securities and Exchange Commission. The problem is that the judges are appointed by an internal panel instead of by the President or the SEC Commissioners. That will not make a difference for Raymond Lucia and his “Buckets of Money.”

In addition to appealing the substance of the charges against him, he argued that the SEC in-house court was unconstitutional. The appeal looked at the Appointments Clause of the Constitution. It’s an important part of the constitution to make sure that those who wield power are subject to “political force and the will of the people.” The President appoints “Officers” who are those who exercise “significant authority pursuant to the laws of the United States.”

The court went out to point out a three prong test to determine if an official is an “Officer” under the Appointments Clause:

significance of the matters resolved by the government official
discretion the official exercises in reaching the decision
the finality of the decision

So far it sounds good for Mr. Lucia and the other parties arguing this point in their disciplinary matters.

But then there is the procedural matter of what happens after an SEC in-house judge issued his or her order. Under the SEC rules, there is not final decision until the Commission determines not to review the order. That initial order from the SEC judge only becomes final when the Commission issues the finality order. “The Commission’s final action is either in the form of a new decision after de novo review or, by declining to grant or order review, its embrace of the ALJ’s initial decision as its own.”

That leaves the full decision-making powers in the hands of the SEC commissioners who are appointed by the President in accordance with the Appointments Clause.

That seems to settle the argument that the SEC in-house administrative proceedings are unconstitutional.

Of course, Mr. Lucia could appeal this decision further. The Supreme Court may want to take a different view of who is an “officer” under the Appointments Clause.

Sources:

Raymond J. Lucia Companies, Inc. v. SEC, No. 15-1345 (D.C. Cir August 9, 2016)
Appeals Court Upholds SEC’s In-House Court as Constitutional by Aruna Viswanatha in the Wall Street Journal
D.C. Circuit Rejects Challenge to Appointment of SEC ALJs by T. Gorman in SEC Actions
Buckets of Money

Buckets of Money

buckets of money

Radio personality Raymond J. Lucia, Sr. got in trouble with the SEC. An administrative law judge made it official and issued an initial decision in the case. Lucia will barred from associating with any investment adviser, broker or dealer, the investment adviser registrations for him and his firm are revoked, and is stuck with a $50,000 penalty against him and a $250,000 penalty against his former IA firm.

Judge Elliot’s decision found that that firm had violated the investment adviser antifraud statutes and that Lucia had aided and abetted the firm’s violations. “Judge Elliot’s initial decision vindicates the Division of Enforcement’s original position that Lucia and RJLC misled the investors who attended their seminars by claiming that the Buckets of Money strategy had been successfully backtested when in fact it had not been,” said Michele Wein Layne, Director of the SEC’s Los Angeles Regional Office.

It’s not over yet. Lucia and RJLC have 21 days from the date of the decision to appeal the decision. I suspect they will appeal.

The SEC found four flaws in Lucia’s performance marketing, with the misleading application of:

historical inflation rates
investment adviser fee impact
returns on Real Estate Investment Trust (REIT) securities, and
reallocation of assets.

The biggest problem cited by the judge was the backtesting use of REITs in the fictional portfolios that went back to 1966. Lucia used an assumed dividend rate of 7%, but is alleged to have failed to disclose that it was an assumed rate. Another problem was using non-traded REITs in the backtest when non-traded REITs were not available during that period. The last problem was that Lucia failed to disclose the illiquidity of non-traded REITs.

Looking at the administrative order it seems that these deficiencies could have been fixed with proper disclosure. Maybe not fixed, but would have reduced the likelihood of the SEC bringing charges and an adverse decision.

One interesting carve-out by the judge was an exclusion of Lucia’s slideshows from the definition of written communications under Rule 206(4)-1(b). The SEC did not show that the slideshow was printed out and distributed.

Sources:

Initial Decision against Raymond J. Lucia, Sr. (.pdf)