The Supreme Court heard oral arguments Wednesday in SEC v. Jarkesy, a case that could decide whether in-house courts used by the Securities and Exchange Commission violate the Seventh Amendment to the Constitution, which guarantees the right to a jury trial in civil common law cases. Formal adjudication by the SEC and other government agencies was instituted by the Administrative Procedure Act of 1946.
George Jarkesy, a hedge fund manager, was charged by the SEC with violating securities laws by misrepresenting two private funds he managed. The SEC alleged that he misrepresented the auditor, prime broker and asset allocation for the funds, which totaled $24 million in assets and were not required to register with the SEC. The SEC fined Jarkesy and his associates almost $1 million in disgorgement and penalties.
Jarkesy challenged the constitutionality of the process under which his case was heard by in-house SEC judges and argued he was entitled to a jury trial before a federal court. After losing in the trial court, Jarkesy found a sympathetic ear with the 5th U.S. Circuit Court of Appeals, which hears cases from Louisiana, Mississippi and Texas.
The 5th Circuit ruled in May 2022 that Jarkesy “had the right for a jury to adjudicate the facts underlying any potential fraud liability that justifies penalties.” The court added in its ruling for Jarkesy that “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 appealed this decision to the Supreme Court. Among other arguments, the SEC explained that Congress delegated this authority to the SEC to bring civil cases for securities laws violations, and internal rulings by its administrative law judges are subject to judicial review.
Though a ruling is unlikely until June 2024, multiple conservative judges signaled during the oral arguments that they were leaning toward Jarkesy.
Justice Samuel Alito asked Justice Department lawyer Brian Fletcher, who represented the SEC, “what sense does it make to say that you have this protection when you are being sued by a private party, whose resources are certainly going to be more limited than the federal government, but when the same thing happens to you, and the party that’s against you is the federal government, well this right to a jury trial simply goes out the window. Does that make sense?”
Impact
If the Supreme Court curtails the authority of agency adjudication or invalidates it altogether, the impact could be far-reaching.
Dustin Nofziger, a counsel at Pryor Cashman LLP, says a ruling invalidating administrative proceedings would “apply directly to financial banking regulators” such as the FDIC and the Federal Reserve Board of Governors, who only use administrative law judges. This “would probably require Congressional action” to give banking regulators other remedies.
Nofziger notes that the SEC already has the authority to bring cases to federal courts, so this “may not be as critical for them.”
Kurt L. Gottschall, a partner in Haynes and Boone LLP, agrees that consequences for the SEC would not be catastrophic, because “the SEC will retain the ability to enforce the securities laws by bringing all of its cases in federal court,” and most of its enforcement actions are already brought before courts.
However, the results would still be difficult for the SEC, which Gottschall notes loses more cases before juries than before administrative law judges, because in traditional courts, “defendants are entitled to much more robust fact-finding in discovery and have greater ability to attack the government’s case through more extensive motions practice,” and “it can be difficult to explain more technical rule violations to juries and to convince them to care about the consequences of violations.”
Gottschall notes that there are certain claims the SEC can only bring administratively, such as barring accountants and attorneys and bringing failure-to-supervise claims against broker/dealers and investment advisers.
If the SEC loses these remedies, “the agency will be in unchartered territory,” he said.
Chance for a Limited Decision
The Supreme Court’s decision might not necessarily invalidate all agency adjudication processes. Justice Neil Gorsuch noted that about 80% of administrative law judges work for the Social Security Administration, and their primary role is adjudicating disputes over benefits, rather than issuing penalties. He suggested that a ruling in the Jarkesy case would probably not extend to them.
Gottschall notes that during oral arguments, some of the justices seemed to be leaning toward allowing the government the “right to adjudicate more obvious ‘public rights’ in other federal administrative forums, such as disputes regarding taxation, immigration, Social Security benefits and customs.”
Nevertheless, “If the court rules against the SEC, it will undoubtedly open up the floodgates for others to challenge the constitutionality of many other federal administrative forums,” Gottschal says, including the Environmental Protection Agency, the Commodity Futures Trading Commission and others that impose fines administratively.
Tags: 5th Circuit, ALJ, EPA, FDIC, SEC, US Supreme Court