Supreme Court Limits SEC’s In-House Adjudicative Powers

On June 27, 2024, in Securities and Exchange Commission v. Jarkesy, the Supreme Court held that the Securities and Exchange Commission’s (SEC or the Commission) administrative process for adjudicating fraud-based enforcement actions involving civil penalties is unconstitutional.^[1]The decision has significant implications for both the SEC’s and other federal agencies’ administrative processes.

Litigation Background

The underlying action dates back to 2011, when the SEC began investigating investment manager 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 initiated enforcement actions against them claiming fraud under the Securities Act, the Securities Exchange Act and the Investment Advisers Act. During the course of the enforcement proceedings, the Respondents filed another action in the District Court of the District of Columbia alleging that the SEC’s administrative enforcement process was unconstitutional. The district court dismissed the Respondents’ claims for lack of subject matter jurisdiction, and the D.C. Circuit affirmed.^[2]

The administrative proceedings continued and the presiding SEC administrative law judge (ALJ) found 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. The Commission’s final order directed 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 Commission’s decision and remanded the case for further proceedings consistent with three groundbreaking holdings on the constitutionality of SEC administrative proceedings.^[4]In a complete rebuke of the SEC’s administrative law process, the court held that the SEC had deprived the Respondents of their Seventh Amendment constitutional right to a jury trial. Applying the two-part test articulated in Granfinanciera, S.A. v. Nordberg,^[5]the Fifth Circuit determined that the SEC’s securities fraud claims were “akin to [a] traditional action[] in debt,” and therefore the Respondents would be entitled to a jury trial if the case were brought in an Article III court. The Fifth Circuit then determined that the “public rights” exception, under which Congress may assign certain matters to an agency decision-maker without running afoul of the Seventh Amendment, did not apply, and therefore the case should have been brought in federal court where a jury could have made factual determinations regarding the Respondents’ fraud liability. The Fifth Circuit also held that 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 that the statutory removal restrictions insulating SEC ALJs are unconstitutional.

The Fifth Circuit denied the SEC’s petition for rehearing en banc in October 2022. As we reported in our July 2023 alert, the SEC filed a petition for certiorari with the Supreme Court, seeking review of the Fifth Circuit’s 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. The Supreme Court granted certiorari in July 2023.

Supreme Court’s Decision

The majority opinion authored by Chief Justice Roberts affirmed the Fifth Circuit’s judgment and held that when the SEC seeks civil penalties against a defendant for securities fraud, the Seventh Amendment entitles the defendant to a jury trial. The Court’s analysis proceeded in two parts. First, following its analysis in Granfinanciera and Tull v. United States, the Court determined that the SEC’s action against the Respondents implicated the Seventh Amendment.^[6]The Court reasoned that the text of the Seventh Amendment guarantees a right to a jury trial for “[s]uits at common law,” and that this right extends to suits involving statutory claims that are “legal in nature.” The Court then concluded that the SEC’s securities fraud action against the Respondents was legal in nature because the SEC sought a remedy of civil penalties, a punitive form of monetary relief traditionally enforced in courts of law (rather than courts of equity). The Court further observed that the similarities between federal securities fraud and common-law fraud — which both target the misrepresentation or concealment of material facts — confirmed that the action was legal, rather than equitable, in nature.  

Second, the Court affirmed the Fifth Circuit’s holding that the “public rights” exception did not apply. Citing matters concerning the collection of revenue, customs law, immigration law, relations with Indian tribes and the granting of public benefits, the Court recognized that certain categories of cases fall within the “public rights” exception. However, the Court concluded that because the SEC sought punitive remedies in its action against the Respondents and targeted the “same basic conduct” as common-law fraud, the action involved private, rather than public, rights and therefore must be adjudicated in Article III courts.

Finally, the Court rejected the SEC’s argument that Atlas Roofing v. Occupational Safety and Health Review Comm’n, where the Court had upheld the constitutionality of the Occupational Safety and Health Administration’s (OSHA) use of administrative hearings to impose civil penalties for workplace violations, was controlling. The majority distinguished Atlas Roofing on the ground that, unlike this case, Atlas Roofing concerned new workplace-safety causes of action that were “unknown to common law.”

Because the Court affirmed on the basis of the Seventh Amendment, the Court declined to reach the remaining questions presented. 603 U.S.___ (2024). No. 22-859, slip op. at 27 (June 27, 2024).

In a concurring opinion, Justice Gorsuch, joined by Justice Thomas, observed that several other constitutional provisions — including Article III and the Due Process Clause of the Fifth Amendment — further supported the Court’s decision. In particular, Justice Gorsuch highlighted that Article III entitles individuals to an independent judge who will preside over the trial by jury guaranteed by the Seventh Amendment, and that the Fifth Amendment’s due process clause provides that any trial will be held in accord with “time-honored principles.” In Justice Gorsuch’s view, the SEC’s administrative law process did not offer the Respondents these constitutional protections, and therefore the Court correctly determined the SEC’s enforcement action should have been adjudicated in an Article III court.

Justice Sotomayor, joined by Justices Kagan and Jackson, dissented. They argued that the SEC’s administrative process passed constitutional muster under the Court’s Atlas Roofing decision. In the dissent’s view, the majority’s decision ignored the long-standing precedent of Atlas Roofing and the realities of federal agencies’ administrative processes. The dissent further cautioned that the majority’s decision jeopardized the separation of powers by limiting Congress’ ability to assign certain public rights matters to federal agencies.

Looking Ahead

The Court’s ruling will likely have significant implications for both the SEC’s and other agencies’ administrative processes. As an initial matter, the decision compels the SEC to pursue enforcement actions seeking civil penalties in federal court and may encourage the agency to be more discerning in its future enforcement efforts or litigation strategy.

Furthermore, the decision raises the question whether any federal regulatory agency can bring administrative proceedings to enforce civil penalties. As the dissent recognized, many federal agencies — including the Commodity Futures Trading Commission, the Consumer Financial Protection Bureau, the Environmental Protection Agency, the Federal Energy Regulatory Commission and the Public Company Accounting Oversight Board — are empowered to impose civil penalties in administrative proceedings. The Court’s decision in Jarkesy may require these agencies to reassess the use of internal administrative processes or dissuade these agencies from seeking remedies traditionally awarded for common-law claims.

^[1]_{Securities and Exchange Commission v. Jarkesy, 603 U.S.___ (2024).}

^[2]_{48 F. Supp. 2d 32 (D.D.C. 2014); 803 F.3d 9 (D.C. Cir. 2015).}

^[3]_{In re John Thomas Capital Management Group d/b/a Patriot 28 LLC, Admin. Proc. File No. 3-15255, 2020 WL 5291417 (Sept. 4, 2020), https://www.sec.gov/files/litigation/opinions/2020/33-10834.pdf.}

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

^[5]_{Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989).}

^[6]_{481 U.S. 412 (1987).}

Summer associate Kevin Paredes assisted in the preparation of this alert.