DOJ Forsakes Defending the ALJ Process Against Article II Challenges

On Feb. 18, 2025, in a case seeking declaratory and injunctive relief against the of the SEC, the U.S. Department of Justice (DOJ) filed a Notice of Change in Position indicating that the DOJ will no longer defend in litigation "the multiple layers of removal restrictions" set forth in 5 U.S.C. § 7521 for Administrative Law Judges (ALJs). Stated otherwise, the DOJ no longer will defend the ALJ system against the argument that it violates Article II of the U.S. Constitution because ALJs are impermissibly insulated from removal by the president.

This "change in position" has not been limited to SEC enforcement actions and, therefore, could have far-reaching consequences for future regulatory enforcement and the administrative state in general. The DOJ has taken the identical position in at least two other litigations – one involving the Federal Deposit Insurance Corporation (FDIC) and another involving the Federal Aviation Administration (FAA) – and, presumably, the DOJ will continue to adopt this same position in other litigations involving other agencies.

However, the situation has been complicated further by the fact that the DOJ also has taken the position in all of the litigations noted above that the plaintiffs still are not entitled to injunctive relief because they have failed to show legal harm. Rather, the DOJ has cited case law holding that actions by an administrative official protected by an unconstitutional removal provision are not automatically unlawful and do not necessarily inflict legal harm. The DOJ has argued that the plaintiffs need to show that the unconstitutional removal provisions actually impacted, or will impact, the actions of the agency against the plaintiff – i.e., a showing that but for the unconstitutional removal provisions, the ALJ would have been removed, the enforcement proceedings would not be occurring or the proceedings would be different. Thus, DOJ is arguing that ongoing administrative proceedings should continue, even though the presiding ALJ is protected by an unconstitutional tenure system. How a plaintiff can successfully show sufficient harm remains to be seen.

The SEC's In-House Forum Takes Another Hit

The change in position was filed in Lemelson v. SEC, pending before the U.S. District Court for the District of Columbia. In his amended complaint in that action, Lemelson has challenged the ability of the SEC to pursue a so-called "follow-on action" against him. Unlike newly filed or oft-called "standalone" administrative proceedings by the SEC, follow-on actions are so named because they literally follow from, and are based on, the entry of an underlying final judgment in the SEC's favor against the same defendant in federal court.

In Lemelson's case, and as we previously covered, the SEC sued him in district court in September 2018 alleging that he and his investment firm, Lemelson Capital Management LLC, violated antifraud provisions of the Securities Exchange Act of 1934 and Investment Advisers Act of 1940 (Advisers Act) in connection with some of his statements against a pharmaceutical company in which Lemelson and his firm allegedly advised a hedge fund – for which it made investment decisions – to amass a sizeable short position. Thereafter, Lemelson allegedly made statements via interviews and written publications about the company, its licensing partner and its flagship drug. The company's stock dropped 16 percent in the days after Lemelson's first report and ultimately fell approximately 34 percent overall. Those losses netted roughly $1.3 million in profit for the hedge fund from the short positions.

Because the final judgment against Lemelson included an injunction and penalty, the SEC's Division of Enforcement initiated a follow-on administrative proceeding seeking to bar or suspend him from the securities industry on the basis that Section 203(f) of the Advisers Act authorizes the SEC to censure, limit the activities of, suspend or bar a person from the securities industry if 1) the person was enjoined from engaging in or continuing any conduct or practice in connection with the purchase or sale of any security, 2) the person was associated with an investment adviser at the time of the alleged misconduct and 3) a sanction is in the public interest. 15 U.S.C. § 80b-3(e)(4), (f).

But Lemelson countered with his own action to stop the SEC in its tracks, claiming (among other things) that because SEC ALJs can be removed only for "good cause" as determined by the U.S. Merit Systems Protection Board (MSPB), "whose leaders themselves can be removed by the President only for good cause," the ALJs' multiple layers of tenure protection violate Article II. Moreover, Lemelson claims, the "SEC's commissioners, who themselves claim for-cause removal protection, cannot remove the ALJ without the approval of MSPB, and the President thus would need to convince both SEC and MSPB to remove the ALJ if he desired to remove him from office."

Article II in the Spotlight

Condensing greatly, the Article II removal challenge depends upon the ALJ representing an executive "officer" within the meaning of Article II, a legal determination turning on the degree of authority and discretion exercised by the ALJ. The U.S. Supreme Court has held that executive officers may not be separated from presidential supervision and removal by more than one layer of tenure protection. Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477 (2010). In particular, if an executive officer can be removed from office only for good cause, then the decision to remove that officer cannot be vested in another official who, too, enjoys good-cause tenure. Id.

The Article II removal challenge is laid out more thoroughly in paragraphs 102 through 118 in the complaint filed by CBW Bank against the FDIC. Notably, this complaint also observes that the FDIC participates in an ALJ-sharing arrangement with the Office of Comptroller of Currency, National Credit Union Administration and Federal Reserve Board. Thus, the Article II removal challenge – and concession by the DOJ – impact the other banking regulators. (The district court dismissed the bank's complaint in its entirety on March 3, 2025, on the grounds of lack of subject matter jurisdiction).

Until now, the DOJ has defended the tenure protections of SEC and other agency ALJs as constitutional – which is not surprising, given the potential consequences of Article II violations, which we discuss below. Generalizing, the DOJ historically has argued that Congress could permissibly conclude that a degree of independence from the Commission would enhance the fairness of the agency proceedings because the sole function of SEC ALJs is to adjudicate individual cases, not exercise broad enforcement or policymaking powers. The DOJ also has argued that the Administrative Procedures Act provides the Commission and the president adequate alternative mechanisms to control an ALJ's exercise of executive power beyond removal. Finally, the DOJ has argued that the Supreme Court's decision invalidating a removal restriction in Free Enterprise Fund is distinguishable because the good-cause removal standard applicable to SEC and other ALJs is less restrictive than the unusually rigorous standard at issue in Free Enterprise Fund. Given this historic defense, the recent change in positions regarding Article II are both unexpected and significant.

As noted, the DOJ nonetheless has argued in each litigation at issue that even with this change in position, the plaintiffs still are not entitled to relief, and that the plaintiffs' Article II claims should be dismissed, because they cannot show that the unconstitutional tenure systems have affected them. DOJ has cited Leachco v. CPSC, 103 F.4th 748 (10th Cir. 2024), which held in part that whether an unconstitutional removal protection has "inflicted harm" justifying relief "remains the same whether the petitioner seeks retrospective or prospective relief[.]"

Potential Consequences

It is unclear at this point whether agencies will simply stop filing enforcement actions before ALJs in light of DOJ's change in position (although ongoing actions still will be defended by DOJ, as reflected above) and/or whether courts will rule affirmatively that Article II has been violated in regard to a particular agency's ALJ system. Of course, there are different types of ALJs, and not all of them necessarily will constitute "officers" under Article II.

Historically, agencies have pursued many enforcement actions through their in-house ALJ system, rather than federal district court. Compared to federal district court, ALJ proceedings can provide several potential advantages to the regulator and disadvantages to the subject of the enforcement action, such as no juries, limited discovery, faster scheduling, laxer rules on the admissibility of evidence, the inability to bring counter-claims, appeals of the ALJ's decision go directly to the regulatory agency itself and a perceived "home court" advantage enjoyed by the regulator. Some of these disparities animated the litigation resulting in the 2024 decision by the Supreme Court in SEC vs. Jarkesy, which held that the Seventh Amendment entitles the defendant to a jury trial when the SEC seeks civil penalties for securities fraud.

An inability or self-imposed refusal to bring enforcement actions before an ALJ likely will diminish a regulator's likelihood of success in many litigations. Further, litigating in federal district court also can require more government resources. Although the legal landscape is still evolving and it is difficult to make reliable predictions at this point, this change in position should alter the respective bargaining power of the regulator and the regulated entity during many underlying examinations in which the regulator finds perceived violations. Certain enforcement actions that previously would have been brought either will be streamlined or simply not be brought at all.

Finally, it is difficult to see how this situation will be resolved quickly. The entire premise of a successful Article II challenge is that an ALJ is protected from removal under Section 7521, and individual ALJs may protest or litigate the issue of how easily they can be fired. Individual agency commissioners may have conflicting perspectives on how to best structure their in-house courts. Or, the current administration may pursue other avenues.

The SECond Opinions Blog will continue to monitor these issues and will provide updates. If you need additional information on this topic – or any topic related to securities enforcement or investigations – please contact the authors or other members of Holland & Knight's Securities Enforcement Defense Team.