The U.S. Supreme Court will hear a challenge to the legitimacy of the Securities and Exchange Commission’s administrative law judges, brought by George Jarkesy, a hedge fund manager. The court will likely hear the case during its next session and rule by June 2024.
The case dates back to 2011, when the SEC began investigating Jarkesy for securities fraud. Jarkesy was managing two hedge funds with more than 100 customers and more than $24 million in assets. Patriot28 LLC was the fund’s adviser and was also charged by the SEC.
The SEC alleged Jarkesy and Patriot28 defrauded investors by misrepresenting who the prime broker and auditor were; mispresenting the parameters and safeguards of the hedge fund; and overvaluing the funds’ assets in order to justify higher fees.
Jarkesy asked the district and appeals courts in the District of Columbia to review the case, and both responded that they did not have jurisdiction, because Congress empowers the SEC to choose whether to bring a case to federal courts (established via Article III of the U.S. Constitution) or to adjudicate it within the agency.
The SEC adjudicated the case and ultimately fined Jarkesy and Patriot28 $300,000 in civil fines and ordered them to repay $685,000 in ill-gotten gains. Jarkesy was also barred “from various securities industry activities: associating with brokers, dealers, and advisers; offering penny stocks; and serving as an officer or director of an advisory board or as an investment adviser,” according to the appeals court’s decision.
Jarkesy appealed to the 5th U.S. Circuit Court of Appeals, based in New Orleans. The appellate court ruled in his favor and found that the SEC’s in-house adjudication system violated the Seventh Amendment guarantee to a jury trial in federal civil matters in which the amount in dispute exceeds $25. The appeals court also found that Congress improperly delegated legislative authority to the SEC by permitting the commission to bring a case before a court or the agency’s own administrative law judges. Lastly, the appeals court ruled that administrative law judges’ protection to not be removed except “for cause” violates Article II of the U.S. Constitution by improperly shielding them from presidential removal.
The appeals court’s decision stated, “Petitioners had the right for a jury to adjudicate the facts underlying any potential fraud liability that justifies penalties” and “Congress unconstitutionally delegated legislative power to the SEC when it gave the SEC the unfettered authority to choose whether to bring enforcement actions in Article III courts or within the agency.”
The SEC then appealed to the Supreme Court, seeking a reversal of the 5th Circuit’s decision.
The case could have profound consequences for the authority and administration of the SEC and other federal agencies, depending on which legal theories the Supreme Court upholds or reverses. In addition to the SEC, at least 20 other federal agencies employ administrative law judges.