From Your Lips to (Fraud's) Ears: Supreme Court Signals a Potential Blow to SEC In-house Enforcement— Part 1 of 2
Last November, the Supreme Court entertained another challenge to administrative authority, hearing oral arguments for SEC v. Jarkesy. The case further extends the wave of constitutional scrutiny facing the Securities and Exchange Commission (SEC), calling into question the commission’s discretion to adjudicate claims in-house before administrative law judges. How narrowly the justices define the ruling has the potential to severely limit the authority of all administrative agencies to adjudicate claims in-house and increase the number of claims brought in federal court.
For the better part of the century, the SEC could only impose civil penalties by bringing an action in federal district court. In 1990, the Securities Enforcement Remedies and Penny Stock Reform Act authorized the SEC to bring actions seeking penalties in administrative proceedings as alternatives to federal district courts against regulated entities. The Dodd-Frank Act of 2010 expanded SEC authority again by allowing the SEC to seek civil penalties for entities it does not regulate in either administrative proceedings or federal district courts.
When a Commissioner orders that a proceeding be heard internally, an administrative law judge (ALJ) oversees the proceeding. An administrative law judge is a judge appointed by the heads of executive agencies to conduct public hearings in a manner similar to federal bench trials, although there are key differences. The American Bar Association notes that “many hallmarks of due process are absent: there is no discovery, the evidentiary rules are relaxed, and guilt is determined by a preponderance of evidence.” ALJ’s have the authority to issue subpoenas, rule on motions, and enforce civil penalties. Most notably, cases held in SEC tribunals before ALJ’s do not have juries.
In 2011, the Securities and Exchange Commission (SEC) opened an investigation into George Jarkesy and subsequently brought an enforcement action for securities fraud. When the SEC filed its claim against Jarkesy, the SEC opted to adjudicate the case in-house before an ALJ.
Jarkesy challenged the SEC’s proceedings in the U.S. District Court for the District of Columbia, citing constitutional infringements. The district court ruled that it lacked jurisdiction, consistent with precedent that required an ALJ must first issue a decision, to be subsequently affirmed or rejected by the Commission, before a decision can be taken to a U.S. Court of Appeals. The Supreme Court has since ruled in SEC v. Cochran that district courts can review constitutional claims challenging the commissions’ power to proceed at all, a finding that may be suggestive of the justices’ openness to strike at the authority of the SEC.
Injunction denied, the hearing proceeded and the ALJ determined that Jarkesy had violated various federal securities laws. They imposed a $300,000 civil penalty on Jarkesy and ordered him to disgorge $685,000, an order subsequently affirmed by the Commission. Jarkesy appealed to the Court of Appeals for the Fifth Circuit, arguing that the SEC violated his constitutional rights by pursuing the enforcement action in an ALJ proceeding rather than in federal court.
The Fifth Circuit vacated the decision of the SEC, holding it triply unconstitutional. The court found (1) Congress violated the nondelegation doctrine when it gave agencies the choice of pursuing administrative or judicial proceedings, (2) the administrative law judge’s assertion of executive power without sufficient control by the agency’s presidentially appointed leaders violated Article II of the Constitution, and (3) the internal adjudication violated Petitioners’ Seventh Amendment right to a jury trial.
Which argument, if any, is the Supreme Court likely to affirm? The first place to look is in the type of questions the justices asked. Though the petitioner and respondent equally divided their introductory remarks between addressing all three claims, the justices exclusively probed counsel to parse out the applicability of the Seventh Amendment.
The official text of the Seventh Amendment reads:
“In suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise re-examined in any court of the United States, than according to the rules of the common law.”
Common law is generally understood to reference the common law of England, from which the American legal system was developed. Parsons v. Bedford, Breedlove and Robeson, 28 U.S. 433 (1830). Since 1812, courts have applied a “historical test” to determine whether the Seventh Amendment applies to a proceeding. See, e.g., United States v. Wonson, 28 F. Cas. 745, 750 (C.C.D. Mass. 1812); Markman v. Westview Instruments, Inc., 517 U.S. 370, 376 (1996); Dimick v. Schiedt, 293 U.S. 474, 476 (1935). Under the test, a jury is required “in cases, including those prosecuted by the government, where a jury would have been impanelled in the courts of England in 1791, the year the Amendment was ratified.”
However, the government does not require all adjudications to be heard by juries. Since America’s founding, the executive branch has been tasked with decisions involving individual rights. Over the last one hundred years, the delegation of authority to executive agencies has dramatically increased, with over 430 departments, agencies, and sub-agencies as of 2015. The Supreme Court has permitted Congress to assign adjudication of claims to agencies when the claim involves a public right. Murray’s Lessee v. Hoboken Land & Improvement Co., 59 U.S. 272 (1856). Public rights, admitted by Chief Justice Roberts to be “not definitively explained” by the Court, typically include federal benefits, entitlements, or new regulatory rights that did not exist in common law but have since been created, like Social Security. Oil States Energy Services, LLC v. Greene’s Energy Group, LLC, 584 U.S. 315 (2018); Crowell v. Benson, 285 U.S. 22 (1932). The issue in this case is whether the SEC’s enforcement actions, particularly fraud-based actions involving civil penalties (as opposed to equitable claims), are public rights or common law claims.
To Be Continued…
Carly Noble (‘24.5) is a senior at Brown University, concentrating in Education Studies with a certificate in Engaged Scholarship. She is a staff writer for the Brown Undergraduate Law Review and can be contacted at carly_noble@brown.edu.
Kourtney Beauvais is a sophomore at Brown University, concentrating in Applied Math-Economics and International and Public Affairs. She is an editor for the BULR and can be contacted at kourtney_beauvais@brown.edu.