Supreme Court Grants Certiorari to Determine Constitutionality of SEC Administrative Law Process

On June 30, 2023, the Supreme Court granted certiorari in Securities and Exchange Commission v. Jarkesy^[1] to review a decision by the Fifth Circuit rejecting key aspects of the Securities and Exchange Commission’s (SEC or the Commission) administrative process and holding that the SEC’s administrative law proceedings are unconstitutional. This case presents significant questions regarding the SEC’s administrative practices and could potentially affect the administrative law process of many other government agencies.

Litigation Background

The underlying action dates back to 2011, when the SEC began investigating George R. Jarkesy Jr., the founding manager of two hedge funds, and Patriot28 LLC, the investment adviser that Mr. Jarkesy selected for the funds (the Respondents). The SEC filed an enforcement action against them alleging fraud under the Securities Act, the Securities Exchange Act and the Investment Advisers Act. During the course of the enforcement proceedings, the Respondents filed a separate action in the District Court for the District of Columbia, claiming that the SEC’s administrative enforcement process was unconstitutional and asking the court to enjoin those proceedings.

The district court in the parallel federal court action dismissed the Respondents’ claims for lack of subject matter jurisdiction, and the D.C. Circuit affirmed.^[2] The Respondents then continued with the SEC proceedings. Following an evidentiary hearing, the presiding SEC administrative law judge (ALJ) decided against the Respondents on the merits, finding that the Respondents violated, aided, abetted and caused violations of the anti-fraud provisions of the federal securities laws.^[3] The Respondents sought review by the SEC itself.^[4] The Commission affirmed the ALJ’s decision and ordered the Respondents to pay a civil penalty of $300,000, ordered Patriot28 LLC to disgorge “ill-gotten gains” amounting to nearly $685,000, and barred Mr. Jarkesy from associating with brokers, dealers and advisers, among other penalties. The Commission also rejected the Respondents’ several constitutional arguments. The Respondents then filed a petition for review in the Fifth Circuit.

Fifth Circuit Court of Appeals’ Decision

As we reported in our May 2022 alert, a split panel of the Fifth Circuit vacated the decision of the Commission and remanded the case for further proceedings consistent with three groundbreaking holdings on the constitutionality of SEC administrative proceedings.^[5] In a full rebuke of the SEC’s administrative law process, the court held that (1) the SEC had deprived the Respondents of their constitutional right to a jury trial, (2) Congress unconstitutionally delegated legislative power to the SEC by granting the agency unfettered discretion in exercising the option to bring enforcement actions administratively before SEC ALJs instead of in federal district courts, and (3) statutory removal restrictions insulating SEC ALJs are unconstitutional. The court emphasized that the first two holdings were independently sufficient to provide grounds for vacating the SEC’s judgment. It therefore did not “decide whether vacating would be the appropriate remedy” for the third issue — the removal question — alone.

Judge W. Eugene Davis dissented, disagreeing with each of the majority’s three holdings. With respect to the Respondents’ constitutional right to a jury trial, Judge Davis argued that under the Supreme Court’s “public rights” doctrine, public rights are those at issue in matters arising between the government and persons under the government’s authority “in connection with the performance of the constitutional functions of the executive or legislative departments.” The public nature of SEC enforcement renders the proceedings against the Respondents a matter of public rights that may be adjudicated in an agency proceeding without violating the Seventh Amendment. Regarding the unconstitutional delegation of legislative power, the dissent argued that the majority misapplied INS v. Chadha’s definition of legislative action and that the majority’s reasoning was inconsistent with other opinions of the Supreme Court, such as United States v. Batchelder.^[6] On the issue of ALJ removability, the dissent argued that the Supreme Court’s decision in Free Enterprise Fund v. PCAOB,^[7] which held that removal protections for members of the Public Company Accounting Oversight Board (PCAOB) were unconstitutional, did not apply to SEC ALJs because SEC ALJs serve an “adjudicative” rather than “executive” function.

The SEC filed a petition for rehearing en banc, which the Fifth Circuit denied in October 2022.

Petition for Certiorari and Looking Ahead

In March 2023, the SEC filed a petition for certiorari with the Supreme Court, seeking review of the Court of Appeals’ decision. The petition presented three questions for the Court’s consideration: (1) whether statutory provisions that empower the SEC to initiate and adjudicate administrative enforcement proceedings seeking civil penalties, without a jury, violate the Seventh Amendment; (2) whether statutory provisions that authorize the SEC to choose to enforce the securities laws through an agency adjudication instead of filing a district court action violate the nondelegation doctrine; and (3) whether Congress violated Article II by granting for-cause removal protection to ALJs in agencies whose heads enjoy for-cause removal protection. In their opposition brief, the Respondents argued that the Fifth Circuit had applied well-settled doctrines of constitutional law and Supreme Court precedent to reach its decision.

The Supreme Court’s decision to grant certiorari signals its willingness to determine definitively the validity of the SEC’s administrative law process. At a time when the Supreme Court has become increasingly skeptical of the expansion of administrative power, the Court’s decision on these questions may significantly alter and further limit the scope of administrative proceedings in many other government agencies.

^[1] _{No. 22-859, 2023 WL 4278448.} 

^[2] _{48 F. Supp. 2d 32 (D.D.C. 2014); 803 F.3d 9 (D.C. Cir. 2015). However, in April 2023, the Supreme Court held that individuals may challenge the constitutionality of an agency’s authority in federal court before receiving a final agency order. See Axon Enterprise, Inc. v. FTC and SEC v. Cochran, 143 S. Ct. 890 (2023). Our client alert reporting on these decisions can be found here.}

^[3] _{In re John Thomas Capital Management Group d/b/a Patriot 28 LLC, Exchange Act Release No. 10834, 2020 WL 5291417 (Sept. 4, 2020), https://www.sec.gov/litigation/opinions/2020/33-10834.pdf.}

^[4] _{While this petition was pending, the Supreme Court decided Lucia v. SEC, which held that SEC ALJs must be appointed in a manner consistent with the appointments clause of the Constitution. Lucia v. SEC, 138 S. Ct. 2044 (2018). Pursuant to Lucia, the Respondents had a right to a new hearing before a constitutionally appointed SEC ALJ but waived this right and continued under the original petition to the Commission.}

^[5] _{Jarkesy v. SEC, 34 F.4th 446 (5th Cir. 2022).}

^[6] _{442 U.S. 114 (1979). In that case, the Court held that it was not a violation of the nondelegation doctrine for Congress to allow prosecutors to choose between two criminal statutes that provide “different penalties, for essentially the same conduct.” The dissent claimed the majority’s treatment of legislative power would characterize a charging decision like this one as an exercise of legislative power, running the opinion into direct conflict with Batchelder.}

^[7] _{561 U.S. 477 (2010).}