End of an Era: Supreme Court Limits SEC’s Use of In-House Courts

Takeaways

• The U.S. Supreme Court, in a 6-3 ruling, has curtailed the SEC’s ability to bring administrative proceedings, via its in-house judicial forum, to impose civil penalties, affirming the right to a jury trial under the Seventh Amendment.
• This decision stems from the SEC v. Jarkesy case, where hedge fund manager George Jarkesy was accused of securities fraud.
• The ruling, along with others issued by the Court this term disassembling the Administrative State, is a significant blow to the enforcement power of federal agencies using in-house tribunals and raises further questions about the constitutionality of administrative law judges utilized by the SEC, CFTC, prudential regulators and potentially SROs.

On June 27, 2024, the Supreme Court issued a stunning decision in the highly watched SEC v. Jarkesy.  The court ruled that the SEC’s use of in-house adjudicatory forums to impose civil penalties in fraud cases violates the Seventh Amendment right to a jury trial. The majority upheld the Fifth Circuit’s decision, stating that when the SEC seeks civil penalties for securities fraud, an analogue to common law fraud, defendants are entitled to a jury trial. The Court’s decision did not address the other constitutional issues of the non-delegation doctrine and removal protections for administrative law judges raised by the Fifth Circuit.

The case began when the SEC initiated an enforcement action against George Jarkesy, Jr., an investment adviser, and his firm, Patriot 28 LLC, for alleged violations of the antifraud provisions contained in federal securities laws. The SEC opted to pursue the matter in-house, and following a hearing before an administrative law judge who is on the SEC payroll, found Jarkesy and Patriot 28 liable for securities violations, imposing a civil penalty of $300,000. Jarkesy and his firm sought judicial review, and the Fifth Circuit vacated the SEC’s order, ruling that adjudicating the matter in-house violated the defendants’ Seventh Amendment right to a jury trial. The Supreme Court affirmed this ruling, holding that when the SEC seeks civil penalties for securities fraud, the Seventh Amendment entitles defendants to a jury trial.

The Supreme Court’s analysis followed the precedent set in Granfinanciera, S. A. v. Nordberg, 492 U.S. 33 (1989) (holding that the Seventh Amendment right to a jury trial applies to fraudulent conveyance actions brought by a bankruptcy trustee because such actions are akin to common law suits and not closely intertwined with the bankruptcy process) and Tull v. United States, 481 U.S. 412 (1987) (holding that the Seventh Amendment guarantees a right to a jury trial in actions for civil penalties because such penalties are legal in nature, designed to punish and deter wrongdoing rather than restore the status quo), concluding that civil penalties for securities fraud are akin to common law fraud and thus require a jury trial. The court rejected the public rights exception, which allows certain matters to be resolved outside of Article III courts without a jury, for several reasons. First, it determined that the claims at issue—securities fraud and the imposition of civil penalties—were akin to common law fraud, which traditionally falls under the jurisdiction of Article III courts rather than administrative agencies. By contrast, the public rights exception typically applies to cases historically determined exclusively by the executive or legislative branches, such as revenue collection, customs law, immigration law, relations with Indian tribes, public land administration, and public benefits. The court found that securities fraud does not fall within these categories because, in substance, the SEC’s action involved civil penalties designed to punish and deter wrongdoing rather than merely restore the status quo. The court also noted that historically, matters involving private rights, such as common law fraud, have been adjudicated by Article III courts under a right to a jury trial.

Justice Sotomayor, joined by Justices Kagan and Jackson, dissented. Justice Sotomayor argued that Congress has historically authorized agency adjudicators to find violations and award civil penalties without jury trials. She emphasized that this practice has been consistently upheld by the Court and that the majority’s decision disrupts longstanding precedent and the established functioning of federal agencies. Justice Sotomayor warned that the majority’s ruling would create chaos for enforcement agencies and challenge the separation of powers by undermining Congress’s ability to assign certain public-rights matters to executive agencies for adjudication.

Implications for the Securities Industry

This decision undoubtedly weakens the SEC’s enforcement power, particularly its ability to impose penalties without going through federal courts. Those facing SEC investigations or actions will likely see an increase in federal court filings as opposed to administrative proceedings. Litigating a jury trial is a more complicated, resource demanding endeavor than pursuing an administrative matter and may therefore force the SEC and other regulators, like the CFTC, to pick which matters to pursue.  This could mean less enforcement in smaller matters and could also mean more favorable settlements for defendants if the regulators become more mindful about resources. 

Although the SEC had already begun reducing its use of administrative enforcement proceedings in recent years, the ruling nonetheless leaves open questions about the future of cases currently before administrative law judges and whether similar challenges might arise in other federal agencies and SROs, like FINRA, using in-house tribunals.

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The Herrick White Collar Defense & Investigations and Securities Litigation & Enforcement team is comprised of lawyers, including former SEC and criminal prosecutors, with decades of experience representing corporations and individuals in regulatory and criminal inquiries.

For more information on this issue or other securities matters, please contact:

Howard R. Elisofon at +1 212 592 1437 or [email protected] 
Arthur G. Jakoby at +1 212 592 1438 or [email protected]
Joshua M. Herman at +1 212 592 1587or [email protected]
Maxim M.L. Nowak at +1 212 592 1464 or [email protected]