The End of SEC Administrative Proceedings? The Supreme Court’s Jarkesy Decision Prohibits the Agency’s Use of ALJs in Enforcement Actions Seeking Civil Penalties

Summary

On June 27, 2024, the Supreme Court decided in SEC v. Jarkesy that where the Securities and Exchange Commission (“SEC”) brings enforcement actions for civil penalties, it must do so in the federal courts, as opposed to before administrative law judges, or “ALJs,” who preside over the agency’s in-house tribunals. In a 6-3 decision written by Chief Justice Roberts, the Court significantly constrained the SEC’s use of administrative proceedings, one of the agency’s key enforcement tools. Moving forward, defendants facing SEC enforcement actions seeking civil penalties are entitled to have their cases heard by juries.

Takeaways

• The Court ruled that the SEC’s use of administrative proceedings to obtain civil penalties in securities enforcement actions violated defendants’ Seventh Amendment right to a jury trial for “suits at common law.” The SEC, therefore, must institute enforcement actions for civil penalties in federal courts before Article III judges.
• Because the Court noted that courts of equity fall outside the scope of the Seventh Amendment, the SEC might continue to pursue administrative proceedings where it pursues equitable remedies such as disgorgement.
• It is unclear how the Jarkesy decision will reverberate across administrative proceedings brought by government agencies more broadly. In a dissenting opinion, Justice Sotomayor noted that the majority’s opinion potentially implicates other agencies’ power to seek civil penalties through administrative proceedings. If so, federal courts may see an increase in caseloads as administrative agencies seeking civil penalties turn to those courts.
• The decision likely will be welcome news to defendants who, as Justice Gorsuch noted in a concurring opinion, have historically fared better in federal court than in the SEC’s in house forum.

Lower Court Decisions

The Supreme Court’s decision comes ten years after an SEC ALJ issued the initial decision that spawned a constitutional challenge to the SEC’s use of its in-house tribunals to punish alleged violators of the securities laws.[1] In 2013, the SEC filed an administrative action alleging securities fraud by hedge fund manager George Jarkesy and his company Patriot28. The ALJ determined by a preponderance of the evidence that Jarkesy violated the antifraud provisions of the federal securities laws. After an appeal to the Commission, the SEC (i) ordered Jarkesy and his company to cease further violations, disgorge $685,000 in what it said were illicit gains, and pay a civil penalty of $300,000; and (ii) barred Jarkesy from working in the securities industry. Jarkesy and his company appealed the judgment in federal court.

On appeal, the Fifth Circuit sided with Jarkesy and held that (1) the SEC’s use of ALJs violated the Seventh Amendment’s right to a jury trial; (2) Congress violated the Constitution’s non delegation principles by failing to provide guidance to the SEC on choosing whether to bring civil actions in federal court or before an SEC ALJ tribunal; and (3) statutory limits on the removal of SEC ALJs violated Article II of the Constitution. The SEC sought review of the Fifth Circuit’s decision in the Supreme Court, and the Court granted certiorari to review all three of the Fifth Circuit’s holdings.

The Supreme Court’s Decision

The Court’s majority opinion, written by Chief Justice Roberts, affirmed the Fifth Circuit’s Seventh Amendment ruling, siding with Jarkesy. The majority reasoned that “[t]he SEC’s anti fraud provisions replicate common law fraud, and it is well established that common law claims must be heard by a jury.” Thus, “[a] defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator.” The opinion further noted that allowing the executive to play “the roles of prosecutor, judge, and jury . . . is the very opposite of the separation of powers that the Constitution demands.”

The Court also distinguished the circumstances of Jarkesy from those present in other cases where the Court had applied the “public-rights” exception to allow certain adjudications outside of Article III courts. The Court found that exception inapplicable to the civil-penalty action at issue in Jarkesy because the Jarkesy case “target[ed] the same basic conduct as common law fraud, employ[ed] the same terms of art, and operate[d] pursuant to similar legal principles.” The Court did not address the remaining two constitutional issues that the Fifth Circuit addressed: the non delegation doctrine and whether SEC ALJs are unconstitutionally protected from removal.

Dissent

A dissent written by Justice Sotomayor and joined by Justices Kagan and Jackson called the majority’s decision a “massive sea change” and rejected the majority’s interpretation of the public rights doctrine exception to the Seventh Amendment, noting that Congress had long given federal agencies the right to adjudicate certain types of cases. According to the dissent, the majority’s opinion erroneously limited Congress’s power to provide federal agencies with authority to decide certain designated cases in administrative proceedings. The dissent pointed to a long line of cases holding that Congress can authorize a federal agency to adjudicate a statutory right and award civil penalties to the government. The dissenting opinion further warned that the majority’s opinion will have “momentous consequences” and threatens “the constitutionality of hundreds of statutes . . . and dozens of agencies could be stripped of their power to enforce laws enacted by Congress.”

Concurrence

A concurring opinion authored by Justice Gorsuch and joined by Justice Thomas emphasized the constitutional basis for opposing administrative agency tribunals and questioned whether ALJs are impartial fact-finders. The concurring opinion highlighted that some data indicates that defendants in SEC enforcement actions fare better in federal court. Justice Gorsuch noted that “the SEC won about 90% of its contested in-house proceedings compared to 69% of its cases in court.” Ultimately, the concurrence concluded that not just the Seventh Amendment, but also Article III and the Constitution’s Due Process Clause mandate that actions seeking civil penalties must be brought in federal court.

Conclusion

It remains to be seen whether the limitations imposed by Jarkesy on the use of ALJs in SEC enforcement actions will extend to other federal agencies. For those defending against SEC actions seeking civil penalties, the Supreme Court’s decision is a significant win as they are now entitled to have these cases brought in federal court rather than by the SEC’s in-house tribunals.

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[1] See In the Matter of John Thomas Capital Management Group LLC d/b/a Patriot28 LLC, George R. Jarkesy, Jr., John Thomas Financial, Inc., and Anastasios “Tommy” Belesis, Initial Decision Release No. 693, Administrative Proceeding File No. 3-15255, Oct. 17, 2014.