Reprinted with permission from Atty Christian Herzeca:
Summary
1-If the Net Worth Sweep is vacated, approximately $190 billion of FNMA and FMCC senior preferred stock held by Treasury should be eliminated.
2-This should cause Fannie’s and Freddie’s public junior preferred stock to appreciate over 300%. Their common stock may appreciate even more.
3-This is a momentous result for any federal district court judge to contemplate. Judge Schlitz in Bhatti oral argument was clearly concerned about the “ripple” effects of granting such remedy.
4-But granting such a remedy appears mandated by SEC v Lucia, a recent SCOTUS case that, like Bhatti, involves an Appointments Clause violation.
5-Six months ago, Judge Schlitz heard oral argument in Bhatti v. FHFA. 6-A transcript of the argument (hereinafter, the “Transcript”) reveals a highly inquisitive judge taking very seriously the constitutional
7-Appointments Clause claim asserted by plaintiff to invalidate the Net Worth Sweep. (For background on the Net Worth Sweep, see my prior articles here and here).Judge Schlitz was unusually candid from the bench in offering his first impressions of the strength of the Appointments Clause claim and the aspects of the claims that he was struggling with.
In particular, Judge Schlitz struggled with the implications of holding that Acting FHFA Director DeMarco had been holding office in violation of the Appointments Clause of the US Constitution, which might render null and void all of the FHFA actions taken by and through the Director’s authority (“I don’t even know, like, what the ripples would be”. (Transcript, p. 62).
Judge Schlitz considered the issue of “redressability” for plaintiff’s claim (Transcript, p. 32-33); that if the proper remedy would be to apply only prospectively a holding that Acting Director was unconstitutionally appointed, then such holding would not offer the plaintiff the relief it was seeking… which would in turn argue for denying plaintiffs’ claim on the merits (“… one of the things I am struggling with on this is it kind of seems like I have to reason backwards from the remedy and that’s, I guess, what redressability makes you do”). (Transcript, p. 32)
A recent SCOTUS opinion in SEC v. Lucia, however, is directly applicable and very significant to Judge Schlitz’s consideration of a remedy if, as Judge Schlitz intimates in oral argument he might, he finds that Acting Director DeMarco’s tenure violates the Appointments Clause on the merits. Lucia stands for the proposition that courts should fashion remedies in a way that “incentivizes” litigants to bring Appointments Clause claims. (“But our Appointments Clause remedies are de-signed not only to advance those purposes directly, but also to create “[]incentive[s] to raise Appointments Clause challenges.” Lucia, p. 12, n.5)
Lucia stands for the proposition that if Judge Schlitz finds an Appointments Clause violation on the merits, he must fashion a remedy that provides the relief plaintiffs are seeking, as an “incentive” for having raised the Appointments Clause challenge. In Bhatti, this would be to invalidate the Net Worth Sweep.
I discuss below the merits of Bhatti’s Appointments Clause claim and how Lucia acts to make it more likely that if, as I expect, Judge Schlitz finds an Appointments Clause violation, Judge Schlitz should find it incumbent upon him to order the invalidation, or vacateur, of the Net Worth Sweep.
The principal issues are: (a) whether SCOTUS precedents holding that administrative law judges (“ALJs”) have been invalidly appointed can be distinguished from the situation where an agency director is claimed to have been invalidly appointed, and (b) whether invalidation of an adjudication by an ALJ with respect to a single litigant (and which affects that litigant) can be distinguished from an agency acting director’s entering into an agreement amendment that has massive financial implications for many investors and the Treasury itself.
To appreciate the merits of the Appointments Clause claim, one would do well to read plaintiffs’ Memorandum of Law in Support of Summary Judgment, FHFA’s Motion to Dismiss, and plaintiffs’ Reply Brief.
The Appointments Clause provides that the President “shall nominate, and by and with the Advice and Consent of the Senate, shall appoint” all officers of the United States. U.S. CONST. art. II, § 2, cl. 2. The Constitution permits only two exceptions to this rule: First, Congress may “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.” Id. (emphasis added). Second, the President “shall have Power to fill up all vacancies that may happen during the recess of the Senate, by granting commissions which shall expire at the end of their next session.” U.S. CONST. art. II, § 2, cl. 3.
In Lucia, much of the analysis centers on whether ALJs were inferior officers for Appointments Clause purposes, or mere employees that were not subject to the Appointments Clause. However, in Bhatti, there is no dispute that Acting Director DeMarco was a principal officer requiring POTUS appointment and Senate confirmation (and not an inferior officer that needed to be appointed by POTUS, courts of agency heads).
In response, FHFA sought to apply a court-made exception to the Appointments Clause requirement, wherein an agency subordinate officer could be appointed by that agency’s principal officer to serve for a limited period of time due to that director’s absence. SCOTUS provided some guidance on that question in the context of another group of officers that require Senate confirmation: consuls.
In United States v. Eaton, 169 U.S. 331(1898), the Court held that a “vice-consul” could “be charged with the duty of temporarily performing the functions of the consular office” for ten months. Id. at 343. “Because the subordinate officer is charged with the performance of the duty of the superior for a limited time, and under special and temporary conditions,” the vice-consul remained an “inferior Officer” and, hence, there was no Appointments Clause violation.
So on this theory, Acting Director DeMarco could lead the FHFA, and enter into the Net Worth Sweep, for a limited time under special conditions notwithstanding that his appointment did not comply with the Appointments Clause.
Yet Acting Director DeMarco fulfilled his entire term, four years and four months, without POTUS appointment and senate confirmation, and had been acting director for two years and four months when he executed the Net Worth Sweep.
Plaintiff argues, by analogy, that if the only express constitutional exception to the Appointments Clause, a recess appointment when the Senate is on recess and therefore unavailable to confirm a POTUS nomination, permits the recess appointee to hold a position for not more than two years, then it makes no sense to permit a non-POTUS nominated and non-Senate confirmed “acting” officer to hold office for more than two years, let alone four years and four months. Judge Schlitz noted in oral argument that this “was a good argument by analogy” (Transcript at p. 63).
As Plaintiff argues, “It would be strange for this densely woven fabric to include a loophole through which the President might introduce permanent, unilateral appointments to the most powerful offices in the Executive Branch. Yet that is precisely what FHFA suggests: that the President may designate acting principal officers to serve indefinitely, thereby frustrating the Senate’s constitutional role. Indeed, FHFA’s interpretation would permit the President as well as the Senate to be cut out of the appointments process for certain independent agencies, by permitting the independent head of a federal agency to select his own acting successor to serve indefinitely, so long as the Senate refused to confirm any presidential nominee.” (Bhatti Memorandum of Law in Support of Summary Judgment, p. 29)
There are additional defenses asserted by FHFA, such as political question/justiciability, res judicata and apparent authority, that would afford Judge Schlitz the opportunity to duck the Appointments Clause claim on the merits. Without getting into further details, I believe that Judge Schlitz will find these defenses are without merit.
Nonetheless, Judge Schlitz, thinking out loud in oral argument, noted that the Appointments Clause cases typically involve ALJs in connection with individual adjudications, one-off events involving the party to the adjudication that can perhaps be retried if necessary.
What the Bhatti plaintiff was asking in relief is to void a contract, the Net Worth Sweep, to which the plaintiff was not a party, since it occurred after the two-year bright line period limit borrowed by analogy from the recess appointment exception, and this in his view would entail making all other actions by Acting Director DeMarco for the last two years and four months of his term to be likewise void.
Judge Schlitz remarks in oral argument “I just can’t find an example – I’ve seen where the Supreme Court has made kind of do-overs on adjudications and discrete decisions. But this kind of turning back the clock, it would be almost unprecedented as far as I can tell.” (Transcript at p. 20).
Now, I have two objections to Judge Schlitz’s trepidation.
First, if it is appropriate for a decision of an inferior officer, an ALJ, to be voided where that ALJ has been improperly appointed, isn’t it even more so the case that it is appropriate to void a decision by a principal officer, who exercises vastly more authority, where that principal officer has been improperly appointed?
Second, by holding that Acting Director DeMarco was unconstitutionally appointed and voiding the Net Worth Sweep, Judge Schlitz precisely would not be holding that all of DeMarco’s decisions and actions for the last two years and four months of his tenure were void. Only the Net Worth Sweep is at issue in the Bhatti case, and Judge Schlitz’s decision would be binding only upon that action that is the subject of the Bhatti case.
Of course, another plaintiff aggrieved by another decision by Acting Director DeMarco could commence its own litigation to seek invalidation of some other action and argue by analogy citing Bhatti. But those other possible and hypothetical cases are not before Judge Schlitz, they may be subject to barriers such as the statute of limitations that make any such additional actions untenable, and Judge Schlitz has no judicial authority to presume that those other cases will arise or be decided on the same basis as Bhatti.
However, the most important consideration for Judge Schlitz to consider is Lucia, which is binding upon him. In Lucia, SCOTUS found an SEC ALJ to have been improperly appointed in violation of the Appointments Clause. The SEC had “ratified” the appointment of the ALJ in a manner that complied with the Appointments Clause after the commencement of the Lucia action.
SCOTUS could have held that this post-hoc ratification cured the Appointments Clause violation and it could have upheld the ALJ’s original adverse determination against Mr. Lucia in the ALJ adjudication.
SCOTUS could also have ordered Mr. Lucia to be retried by the same ALJ given that his appointment was now ratified.
But SCOTUS did neither of these things. Rather, SCOTUS ordered that Mr. Lucia be retried by a different ALJ than the original ALJ who had adjudicated Mr. Lucia’s case.
SCOTUS selected this remedy because, as Justice Kagan noted, “our Appointments Clause remedies are designed not only to advance those purposes directly, but also to create “[]incentive[s] to raise Appointments Clause challenges.”
Given Lucia’s admonition to federal judges to craft Appointment Clause remedies in a manner to incentivize Appointments Clause challenges, I believe Judge Schlitz has received the judicial sustenance he was looking for during oral argument. Permitting him to “work back from the remedy,” but now knowing that the Bhatti remedy must be of a nature that incentivizes plaintiffs to bring the cases that allege the Appointments Clause violation, I believe that Judge Schlitz should vacate the Net Worth Sweep.
Disclosure: I am/we are long FNMA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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