Supreme Court Update: South Dakota v. Wayfair (17-494), Lucia v. Securities and Exchange Commission (17-130), Wisconsin Central v. United States (17-530)

June 22, 2018 Supreme Court Update

Greetings, Court Fans!

We're getting there. Four more decisions this morning, including one of the A-list blockbusters of the term, Carpenter v. United States (No. 16-402), in which the Court limited the "third-party records" doctrine and held that the Government's acquisition of cell-site records from wireless carriers is a search under the Fourth Amendment. The decision, to paraphrase Joe Biden, is a big . . . deal. But we'll tell you why later! Also decided this morning: Ortiz v. United States (No. 16-1423), holding that a military judge's simultaneous service on the Court of Criminal Appeals for the Air Force and the Court of Military Commission Review does not violate either the Appointments Clause of the Constitution or the federal statute prohibiting active-duty military officers from holding a second job requiring presidential nomination and Senate confirmation; Currier v. Virginia (No. 16-1348), holding that, where a criminal defendant indicted on multiple charges agrees to have them tried separately, his acquittal on the first tried count does not preclude him from being tried on the subsequent counts; and WesternGeco v. ION Geophysical Corp. (No. 16-1011), holding that Section 284 of the Patent Act may be applied extraterritorially to permit recovery of lost foreign profits.

Because Ortiz resulted in DIGs of its companion cases, Dalmazzi v. United States (No. 16-961) and Cox v. United States (No. 16-1017), we're down to six more cases for the rest of the term. The Court will be back Monday, and we'd expect one more day of announcements next week. But let's not get ahead of ourselves. We've still got to catch up with yesterday's decisions, including one of the more anticipated decisions of the term, South Dakota v. Wayfair (No. 17-494), in which the Court reversed fifty years of precedent and held that states can, without violating the dormant Commerce Clause, require internet retailers to collect and remit sales taxes even if the retailers do not have a physical presence in the state. The dispute among the Justices had little to do with the substance of Commerce Clause requirements; all nine Justices agreed that the original case requiring a physical presence, National Bellas Hess, Inc. v. Dep't of Revenue of Ill. (1967) was antiquated and wrongly decided. They disagreed, however, on the import of stare decisis, the economic impact of overruling established law that has spawned the growth of on-line retail business, and deference to Congress.

In Bellas Hess, the Court held that a mail order company that had no physical presence in Illinois could not be required to collect the state's sales tax. The Court's view, in 1967, was that out-of-state mail order companies engaged in interstate commerce would be unduly burdened by having to track sales and comply with varying tax requirements in all 50 states. Twenty-five years later, in Quill Corp. v. North Dakota (1992), North Dakota urged the Court to overrule Bellas Hess, arguing that substantial changes in retailing and the advent of computer technology eliminated the need for a constitutional requirement of physical presence in a taxing state. The Court declined to do so, though three of the Justices (including Justice Kennedy) reached that decision solely on the basis of stare decisis. Only Justice White dissented. As on-line retailing exploded in the ensuing years, Quill came under increasing attack from brick-and-mortar retailers who were still obligated to collect state sales taxes and states that were losing billions in potential sales tax revenues. In 2016, South Dakota directly challenged Bellas Hess and Quill by eancting a law requiring online retailers with more than $100,000 in sales to collect sales tax, even if they had no physical presence in the State. A group of online retailers, including Wayfair, challenged the constitutionality of the statute, urging the Court to continue to follow Quill.

Justice Kennedy's opinion for the Court (joined by the unusual coalition of Justices Thomas, Ginsburg, Alito and Gorsuch), overruled Bellas Hess and Quill as inconsistent with current economic reality and with core Commerce Clause principles. The world of "modern e-commerce does not align analytically with a test that relies on the sort of physical presence defined in Quill," he wrote. And it creates anomalous results. Under Quill, a business with a single salesperson in every state would have to collect sales taxes everywhere, but a business with 500 salespersons in one state and a website accessible in every state need not do so, even if its nationwide sales were identical. By perpetuating the physical presence requirement, Quill thus embraced the type of "arbitrary, formalistic distinctions that the Court's modern Commerce Clause precedents disavow." Quill also created economic distortions. It served as a "judicially created tax shelter" for businesses that operate on-line, at the expense of local businesses and interstate businesses that intentionally limit their physical presence in states. Kennedy specifically pointed out a Wayfair advertisement that boasts "we do not have to charge sales tax." Though Justice Kennedy acknowledged the importance of stare decisis, he concluded that the "present realities of the interstate marketplace" that have developed in the decades following Quill and Bellas Hess justified overturning them. Since Quill, the percentage of Americans with Internet access grew from 2% to 89%, and e-commerce retail sales today are more than quadruple the amount of mail order sales in 1992. As a result, states have seen a concomitant loss of tax revenues—a point underscored by the 42 states that joined an amicus brief urging the Court to overrule Quill. Justice Kennedy also recognized the potential burden of complying with the byzantine variations in state and local sales tax laws, but assumed that software developments will eventually ease that burden. And many states are likely to be careful in imposing tax collection obligations. Some, like South Dakota, provide a safe harbor for companies that only have limited sales in the state and bar retroactive collection of past taxes. Finally, though Kennedy agreed that Congress would be better positioned to change Quill's physical presence rule and address the thorny issues that will follow, he insisted that the Court should not "ask Congress to address a false constitutional premise of this Court's own creation."

Justice Thomas penned a brief concurrence, chiefly to express remorse for not joining Justice White's dissent in Quill and, for good measure, to register his belief that "the Court's entire negative Commerce Clause jurisprudence" can no longer be rationally justified. Gorsuch, too, wrote a brief concurrence to signal his belief that the Court's dormant Commerce Clause jurisprudence may be on shaky constitutional ground.

The Chief Justice dissented, joined by Justices Breyer, Sotomayor, and (for the first time ever) Kagan. For the Chief, the development of the Internet and of dramatic changes in the national economy counsel in favor of retaining the physical presence rule, even though he agreed Bellas Hess was wrongly decided. "E-commerce has grown into a significant and vibrant part of our national economy against the backdrop of established rules, including the physical-presence rule." Changing the rule now, the Chief Justice feared, might well "disrupt the development of such a critical segment of the economy." The entire purpose of stare decisis, after all, is to permit persons—States, retailers, consumers—to organize their affairs around predictable and stable rules. In the Chief's view, "if stare decisis applied with special force in Quill, it should be an even greater impediment to overruling precedent now." That is particularly so in light of the fact that Quill expressly left it to Congress to decide whether to intervene. Indeed, as the Chief noted, Congress has been working on interstate sales tax collection and is considering three bills right now that would address the issue. By overturning Quill, the Court will make it harder, not easier, for Congress to step in and pass legislation that can deal with the problem in a more comprehensive manner. The Chief expressed puzzlement at the majority's sense of urgency, noting that state and local governments currently collect about 80% of the sales tax revenue that they'd receive in the absence of a physical-presence requirement. In his view, the problem that Bellas Hess created was, in effect, being solved by the market and the Court was simply "compounding its past error by trying to fix it in a totally different era." Inasmuch as Congress has the authority to regulate commerce among the states, the Chief and the other dissenters would leave it to Congress to "decide whether to depart from the physical presence rule that has governed this area for half a century."

Next up, in Lucia v. Securities and Exchange Commission (No. 17-130), the Court resolved a recently emerged circuit split over whether the SEC's Administrative Law Judges ("ALJs") are "officers" or "employees" of the United States. That distinction matters, because it determines how they must be appointed. And it could matter in other perhaps more consequential ways, such as whether laws protecting ALJs from removal except for good cause are constitutional. But the 7-2 majority didn't reach these more consequential questions, and the narrow way in which the Court decided the officer/employee distinction is unlikely to provide much guidance for future disputes about whether particular government positions are officers or employees.

The Appointments Clause of the Constitution, art. II, § 2, cl. 2, provides that "Officers of the United States" must be appointed by the President, a court of law, or the head of a department. This distinguishes them from mere "employees," who can be appointed in whatever way is statutorily authorized. Two decisions of the Supreme Court set out the basic framework for distinguishing between an "officer" and an employee. First, under United States v. Germaine (1879), an officer's duties must be "continuing and permanent" as opposed to "occasional or temporary." Second, under Buckley v. Valeo (1976), only officers may "exercise significant authority pursuant to the laws of the United States." But in the years since Buckley, the Court has provided little guidance about what it means to "exercise significant authority pursuant to the laws of the United States."

That leads to the facts of the present case: One of the primary ways the SEC enforces the securities laws is by instituting administrative proceedings. While the Commission itself may preside over such proceedings, it usually delegates that task to an ALJ. These ALJS (of which there are now five) are hired by the SEC's staff, not the Commission directly. Once assigned to hear an enforcement proceeding, an SEC ALJ acts more or less like a judge, supervising discovery, deciding motions, taking evidence, and ultimately issuing an "initial decision" setting out findings of fact and conclusions of law, including the appropriate form of relief (such as a sanction). The Commission can review the ALJ's decision, either sua sponte or on request (and it almost always does so if someone makes the request). But it can also decide against review, in which case it issues an order stating that the ALJ's decision is final. By law, the initial decision then is "deemed the action of the Commission."

In this case, the SEC initiated an administrative proceeding against Raymond Lucia, who developed and marketed a retirement savings strategy called "Buckets of Money." Although having buckets of money sounds like a good strategy for retirement, Lucia allegedly marketed it using misleading presentations. The SEC charged him with violating the Investment Advisors Act, and assigned an ALJ, Cameron Elliot, to adjudicate the case. After a nine-day hearing, ALJ Elliot issued an initial decision finding that Lucia had violated the Act and imposed sanctions, including a $300,000 civil penalty and a lifetime bar from the investment industry. Lucia appealed to the SEC arguing, among other things, that the proceedings were invalid because ALJ Elliot was an officer who had not been constitutionally appointed—he had been appointed by the SEC staff rather than the President, a court, or the head of a department. The SEC rejected his argument, as did the D.C. Circuit when he sought review. Sitting en banc, an equally divided D.C. Circuit affirmed, in the process disagreeing with the Tenth Circuit, which had concluded just the year before that the ALJs were officers. Lucia sought certiorari.

Before the Court had a chance to rule on Lucia's petition, however, something Trump-y happened: The Government switched sides. Throughout the course of proceedings, the Government (as it had done for decades) argued that SEC ALJs were employees, not officers. But the new administration took the opposite position, asking the Court to grant cert and hold that ALJs were officers who must be appointed as such. Why the flip? Because the Government also asked the Court to decide a second question: Whether statutory restrictions on removing the SEC's ALJs only for good cause are unconstitutional (a useful question to have answered if, hypothetically, you wanted to be able to fire ALJs whose decisions you don't like). The Court decided to take up the first question, but declined to grant cert on the second (and declined again to consider the issue when it was raised by the government in merits briefing). Because there was now no one on the other side, the Court appointed an amicus to argue against Lucia.

Even though the Court refused to consider the removal question, many still felt Lucia would be a consequential decision, for the outcome could have implications for wide swaths of government personnel found to be officers. But the Court's opinion, written by Justice Kagan and joined by the five conservative Justices (with Justice Breyer concurring in part in the result) was—you guessed it—narrow. Justice Kagan expressly declined to put some meat on the bones of the officer definition from Germaine and Buckley. Instead, she concluded that the case could be resolved entirely by a third case, Freytag v. Commissioner (1991). That case held that, whatever "significant authority" means exactly, it certainly covers the U.S. Tax Court's "special trial judges" ("STJs"), given the judge-like duties they exercised in tax proceedings. And it just so happens that STJs and the SEC's ALJs hold office pursuant to similarly drafted statutes and exercise the same "significant discretion" in carrying out the same "important functions." (We could go through the powers and discretion in detail, but take our word for it: STJs and ALJs do pretty much the same things.) Thus, it was unnecessary to issue some broad pronouncement of what Buckley's "significant authority" standard means because Freytag already said "everything necessary to decide this case."

That left only the remedy: Because Lucia had timely objected to the appointment of ALJ Elliot, he was entitled to a new hearing before an appropriately appointed official. Importantly, while the case had been pending, the Commission itself (the head of a department) had ratified the appointment of all its ALJs, curing any constitutional deficiency from their being appointed by the SEC staff. But the "appropriately appointed official" who now would hear Lucia's case on remand couldn't be ALJ Elliot, the majority held, because ALJ Elliot had already heard Lucia's case and issued a decision on the merits, and so he couldn't reasonably be expected to consider the matter anew. Accordingly, Lucia gets not just a new hearing but a new hearing before some other (validly appointed) ALJ.

Never one to shy away from broad pronouncements, Justice Thomas wrote separately to explain the original meaning of "Officers of the United States," in a concurring opinion joined by Justice Gorsuch. In his view, the Founders would've understood this term to mean all federal civil officials performing an ongoing, statutory duty, no matter how significant (or insignificant) that duty is. That interpretation would plainly have covered the SEC's ALJs. It also presumably would cover a lot more (possibly the vast majority of federal government personnel), but Justice Thomas understandably found it unnecessary to explain exactly how this standard might apply to lots of other government personnel.

Justice Breyer also concurred in the result, but under a statutory as opposed to constitutional rationale. Specifically, he argued that the Administrative Procedure Act governs the appointment of ALJs and provides that "each agency" shall appoint as many as it deems necessary. But nothing in the APA gives the Commission the power to delegate the authority to appoint ALJs to its staff, at least not without some validly issued order or rule (of which there were none). Why this different approach? Because Justice Breyer was concerned about the lurking issue in this case (the issue the Court had declined to consider at the government's urging): If ALJs are officers of the United States then there's a good argument that protecting them from removal except for good cause (which good cause must be found by the Merit Systems Protection Board, whose members are also protected by removal except for cause) violates Free Enterprise Fund v. PCAOB (2010). Justice Breyer opined that it wouldn't, for various reasons, but to avoid even raising that issue, he believed the Court should decide this case under the narrower statutory rationale. Justice Breyer also dissented (joined by the other dissenters) from the Court's conclusion that ALJ Elliot couldn't hear the case on remand, noting that courts remand cases to lower judges all the time with the expectation that they will be able to decide the case again without the taint of any prior deficiency. So why shouldn't the same be true here?

Justice Sotomayor dissented, joined by Justice Ginsburg. She concluded that in order to exercise "significant authority," a person must be able to make "final, binding decisions on behalf of the Government." That standard wouldn't be met by the SEC's ALJs, because they just issued "initial decisions" subject to SEC review. And even when the SEC declined to review them formally, it was required to issue an order adopting the decision, meaning that it had the legal status of an SEC decision. In this respect, ALJs arguably differed slightly from the STJs at issue in Freytag who could, in (admittedly) rare circumstances, issue final decisions that bind the government or third parties.

Finally, for those of you still with us, we're pleased to reward you with a railroad pension case. (You can thank us later.) In Wisconsin Central v. United States (No. 17-530), the Court held that employee stock options are not taxable "compensation" under the Act because they are not "money remuneration." As you surely know, the Railroad Retirement Tax Act was enacted during the Great Depression, when struggling railroad pension funds reached the brink of insolvency. Because privately owned railroads employed large numbers of Americans and were vital to U.S. commerce, the Government passed a bailout. Under the Railroad Retirement Act, which is still in force, railroad employees pay a special tax on their income and, in return, the federal government provides generous pension funds. This case involved a peculiar feature of the Act, which provided that employees only had to pay taxes on "money remuneration." At the time the Act was passed, this was meant to distinguish between the in-kind benefits (such as meals, transportation, and lodging) that the railroads provided to their employees. However, the Courts of Appeal had recently split on whether "money remuneration" covered other types of compensation such as stock options.

Writing for the 5-4 majority, Justice Gorsuch held that when Congress said "money" it meant "money." You know, big ones, dollarinies, doughnuts. Recognizing that "money" in 1937 commonly meant a currency "issued by a recognized authority as a medium of exchange," Justice Gorsuch wryly observed that no one would describe a car as being worth "2450 shares of Microsoft," and you'd be hard pressed to pay your tax bill with stock options. Adding the word "remuneration" to the word "money" did not change the result – it merely indicated that Congress wanted to tax monetary compensation among the different types of remuneration an employer may offer. Moreover, the Act was specifically designed to exclude in-kind remuneration, further bolstering the idea that Congress intended to tax only that compensation that was actually in the form of currency. The broader statutory context supported this narrow interpretation of "money remuneration," Gorsuch argued. For example, the Internal Revenue Code of 1939 treated "money" and "stock" differently in its provisions. Moreover, a companion act enacted by the same Congress—the Federal Insurance Contributions Act (FICA)—taxed "all remuneration" including benefits "paid in any medium other than cash." The fact that the same Congress made the distinction between "money" and "all" remuneration indicates that it intended the Railroad Retirement Tax Act to be deliberately narrow. Moreover, the IRS in 1938 enacted regulations that explained that Railroad Retirement Act was designed to tax "all remuneration in money, or in something which may be used in lieu of money (scrip and merchandise orders, for example)." The regulation indicated that this includes "salaries, wages, commissions, fees, and bonuses." Stocks and stock options were not mentioned.

Leading the dissent, Justice Breyer argued that money can have a more expansive meaning, which includes any "property or possessions of any kind viewed as convertible into money or having value expressible in terms of money." The majority conceded that this was a potential definition, but not the ordinary definition. Because almost anything could be reduced to a "value expressible in terms of money," the majority thought this was an idiosyncratic and virtually unworkable definition. If Congress wanted "money remuneration" to cover virtually anything, the majority wondered, why would they take such pains to distinguish between "money" and "all" remuneration? Moreover, while the dissent claimed that the majority's interpretation would create some surplusage problems, the majority noted that the dissent's interpretation would eviscerate the Internal Revenue Code, which consistently and often distinguishes between "money" and "stock." Finally, the majority refused to give the IRS Chevron deference on the issue because the textual and structural clues made it clear enough that the term "money" excludes "stock" and therefore there was no ambiguity triggering agency deference. As a result, railroad employees can enjoy their tax-free stock options and still receive a tidy pension.

That's enough for this week. Stay tuned Monday as we bring you news of the newest decisions, and more summaries of the not-as-new decisions.