The Supreme Court recently issued its opinion in SEC v. Jarkesy, addressing the constitutionality of the Securities and Exchange Commission's (SEC) in-house adjudication system. In cases brought by the SEC in federal court, defendants are entitled to the right to a trial by a jury of their peers and the presence of an independent trier of fact, among other protections. These protections, however, do not exist for defendants when the SEC chooses to bring an action before its in-house tribunal.
While George Jarkesy raised multiple constitutional challenges in response to being forced to litigate in the SEC’s home court, the primary dispute in Jarkesy turned on whether he was entitled to a jury trial before an Article III judge to determine whether he had violated the federal securities law, or whether the government acted properly when it chose to try him instead before an official hired by the SEC known as an administrative law judge (ALJ). The Supreme Court held that when the SEC seeks civil penalties against a defendant for securities fraud, its in-house adjudication system violates the Seventh Amendment, which guarantees the right to a jury trial in civil cases. The Court rejected the SEC’s argument that the public rights exception applied to this case.
This decision has significant implications for the enforcement of securities laws and the rights of defendants in SEC proceedings. More broadly, Jarkesy will impact federal agencies that enforce statutes and rules through their administrative courts. For example, agencies such as the U.S. Department of Health and Human Services (HHS), the Food and Drug Administration (FDA), and the U.S. Department of Agriculture (USDA), which routinely seek civil penalties before their ALJs, will be immediately affected. In contrast, the decision is likely to have little immediate impact on the Federal Trade Commission (FTC), which, despite its use of ALJs in some matters, is already required to seek civil penalties in federal district court.
Factual and Procedural Background
In 2013, the SEC brought an enforcement action against George Jarkesy, Jr. and his advisory firm, Patriot28, LLC, alleging securities fraud. The SEC claimed that Jarkesy and Patriot28 misled investors about their investment strategies, the identity of their auditor and prime broker, and the value of the funds, resulting in inflated management fees. The SEC had two options for where to bring the claims against Jarkesy. The SEC chose to adjudicate the case before one of its ALJs rather than in federal court.
The ALJ ruled against Jarkesy, and the SEC reviewed this decision, subsequently issuing its final order. The order levied a civil penalty of $300,000 against Jarkesy and Patriot28, directed them to cease and desist from committing or causing violations of antifraud provisions, ordered Patriot28 to disgorge earnings, and barred Jarkesy from participating in the securities industry.
Jarkesy appealed this order to the Fifth Circuit Court of Appeals, arguing that the SEC’s choice of forum violated his Seventh Amendment right to a jury trial. Jarkesy also asserted that Congress violated the non-delegation doctrine by authorizing the SEC, without adequate guidance, to choose whether to litigate the action against him in an Article III court or to adjudicate the matter itself. Additionally, Jarkesy raised the issue of insulation of the SEC ALJs from executive supervision through two layers of for-cause removal protections, which Jarkesy argued violated the separation of powers.
The Fifth Circuit panel held that the agency’s decision to adjudicate the matter in-house violated the Seventh Amendment and also agreed with Jarkesy’s other constitutional challenges. After the Fifth Circuit denied rehearing en banc, the SEC appealed the decision to the Supreme Court, and the Supreme Court agreed to hear the appeal.
Supreme Court's Ruling
Civil Penalties in Securities Fraud Cases Implicate the Seventh Amendment
The Supreme Court ruled in favor of Jarkesy, holding that the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties against him for securities fraud. Notably, the Supreme Court did not rule on the non-delegation or for-cause removal issues because the Seventh Amendment issue was dispositive. Chief Justice Roberts, writing for the majority, emphasized that the right to a jury trial is a fundamental constitutional protection. The Court applied the principles from Granfinanciera v. Nordberg and Tull v. United States, determining that the SEC’s claims were akin to common-law fraud, which traditionally requires a jury trial.
The Seventh Amendment provides that civil litigants generally have a right to a jury trial “in suits at common law.” The Court explained that, in determining whether a statutory violation, such as securities fraud, constitutes a “suit at common law,” the “remedy is all but dispositive.” Civil penalties seeking “money damages” are the prototypical common-law remedy. The key factor is whether a monetary remedy is designed to punish or deter the wrongdoer or is intended solely to “restore the status quo.” Damages designed to punish are “a type of remedy at common law that could only be enforced by courts of law.” Therefore, suits claiming damages of a punitive nature are protected by the Seventh Amendment.
The Supreme Court ruled that the SEC’s civil penalty was clearly punitive rather than restorative. As evidence, the Court noted that both the Securities Exchange Act and the Investment Advisers Act tie the availability of civil penalties to the perceived need to punish the defendant rather than to restore the victim. The penalty size depends on the defendant’s culpability and need for deterrence, not the harm caused. Moreover, the SEC is not required to return money to victims. As such, the civil penalty sought by the SEC implicated Seventh Amendment protections, entitling Jarkesy to a jury trial, which the SEC’s in-house adjudication system deprived him of.
The Public Rights Doctrine Does Not Apply to Securities Fraud Claims
The Court rejected the SEC’s argument that the public rights exception applied in this case. The public rights doctrine allows Congress to assign adjudication of “public rights” to administrative agencies without a jury trial. However, the Court found that securities fraud claims are private rights, not public rights.
The Constitution prohibits Congress from “withdrawing from judicial cognizance any matter which, from its nature, is the subject of a suit at common law.” The Court clarified that it does not matter if the claim arises from a statute; if the claim resembles a traditional legal claim, its statutory origins are not dispositive. Securities fraud suits target the same basic conduct as common-law fraud, use the same terms of art, and follow similar legal principles. The remedy for securities fraud is punitive, not remedial. Therefore, a securities fraud claim is “a common law suit in all but name.” Because securities fraud claims involve disputes between private parties over traditional common-law issues, the public rights exception did not justify denying Jarkesy a jury trial.
Accordingly, the ruling mandates that the SEC must bring contested enforcement actions seeking civil penalties in federal court, where defendants are entitled “to be tried by a jury of his peers before a neutral adjudicator.”
Dissent
Justice Sotomayor, joined by Justices Kagan and Jackson, authored a dissent and called the majority’s decision a “massive sea change.” Justice Sotomayor rejected the majority’s interpretation of the public rights doctrine exception to the Seventh Amendment, arguing that Congress had long given federal agencies the right to adjudicate certain types of cases. According to Justice Sotomayor, the majority’s opinion unjustly limited Congress’s power to provide federal agencies with authority to decide certain designated cases in administrative proceedings. The dissent ended with a warning that the majority’s opinion will have “momentous consequences” on the effectiveness of administrative agencies.
Concurrence
Justice Gorsuch, joined by Justice Thomas, authored a concurring opinion and emphasized the constitutional basis for opposing administrative agency tribunals and questioned whether ALJs are impartial fact finders. Arguing against the impartiality of ALJs, Justice Gorsuch noted that “the SEC won about 90% of its contested in-house proceedings compared to 69% of its cases in court.” Notably, the concurrence concluded that the Constitution’s Due Process Clause also mandates that actions seeking civil penalties must also be brought in federal court.
Implications for Other Federal Agencies
The Supreme Court’s holding that civil penalties are equivalent to statutory penalties could significantly impact other federal administrative agencies. The effect will vary depending on each agency’s structure and how it currently pursues monetary penalties, whether through the administrative process or through federal court. While certain agencies, such as the FTC, can only pursue civil penalties in district court, other agencies have more permissive enabling statutes that allow them to pursue these penalties in-house, making them significantly more impacted by Jarkesy. Observers have noted that the HHS, FDA, and USDA, in particular, often pursue civil penalties through administrative procedures, which are likely to be challenged post-Jarkesy.
While the Supreme Court only ruled on the Seventh Amendment issue, it left open two other important issues that could profoundly affect the structure and process of many government agencies: (1) 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 non-delegation doctrine; and (2) whether Congress violated Article II by granting for-cause removal protection to ALJs in agencies whose heads have for-cause removal protection.
Because the Supreme Court did not address these issues, the Fifth Circuit’s non-delegation and removal holdings remain good law, at least in the Fifth Circuit. This could ultimately impact the structure and process of agencies with enabling statutes similar to the SEC’s, including the FTC, because the FTC Act allows the agency to choose whether to sue parties in federal district court or in internal administrative tribunals (although not, as noted above, when they are seeking civil penalties). Additionally, agencies with ALJs who enjoy “double insulation” of for-cause removal, similar to SEC ALJs, such as the Drug Enforcement Agency, Consumer Financial Protection Bureau, and FTC, are impacted by the Fifth Circuit’s holding. Importantly, other courts of appeal may reach conclusions different from the Fifth Circuit’s decision, producing a “circuit split” and necessitating the Supreme Court to reexamine these issues.
In a further trend toward the limitation of agency powers, Jarkesy will have an important interplay with the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, which overruled the longstanding Chevron doctrine and held that courts should not defer to agency interpretations of statutes simply because the statutes are ambiguous. That decision likely will add to the challenges faced by the FTC, and other agencies, in writing and enforcing rules. For more information concerning the wide-ranging implications of the Supreme Court overruling the Chevron doctrine, please see our July 10, 2024 webinar covering the topic.
Conclusion
The Supreme Court’s decision in SEC v. Jarkesy marks a significant shift in the enforcement of the securities laws and the potential for upending the structures and processes of other administrative agencies. Rather than face constitutional challenges like those asserted by Jarkesy, the SEC has for several years been bringing contested enforcement actions in federal court. Thus, as to the SEC specifically, SEC v. Jarkesy could be said to make permanent what has already become the status quo.
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