Jarkesy v. SEC: What is its potential impact?

Jones & Keller, P.C.

The U.S. Supreme Court ruling in Jarkesy found that the SEC’s choice to vindicate fraud claims through its own administrative process violated the constitution for three separate reasons. What does that mean for administrative hearings going forward?

When the Securities and Exchange Commission (SEC) decides to pursue formal enforcement proceedings against a company or individual, it can choose whether to do so in an Article III court, or through the SEC’s own administrative process in which the agency acts as the rulemaker, prosecutor and judge. However, things are different when the SEC decides to bring a claim against a company or individual for securities fraud. In a recent ruling by the U.S. Court of Appeals for the Fifth Circuit, Jarkesy v. Sec. & Exch. Comm’n, 34 F.4th 446 (5th Cir. 2022), the Court found that the SEC’s choice to vindicate fraud claims through its own administrative process violated the constitution for three separate reasons.

First, the Court found that the SEC’s in-house adjudicative process for fraud claims is unconstitutional because it violates the Seventh Amendment right to a jury trial. “Congress cannot change the nature of a right, thereby circumventing the Seventh Amendment, by simply giving the keys to the SEC to do the vindicating.” Id. at 457. Fraud claims must therefore be vindicated in an Article III tribunal, not in-house at the SEC.

Second, Jarkesy applied the “nondelegation doctrine,” which is a theory that Congress cannot delegate its legislative powers to the executive branch, and concluded that when Congress gave the SEC “the ability to determine which subjects of its enforcement actions are entitled to Article III proceedings with a jury trial, and which are not[,]” that was an unconstitutional delegation of legislative power. Id. at 461.

Third, Jarkesy found that the removal restrictions that apply to SEC administrative law judges (i.e., the rules that apply when the President wants to terminate an ALJ’s employment) violate Article II because they interfere with the President’s ability to “take Care that the Laws be faithfully executed.” Id. at 463 (citing U.S. Const. art. II, § 3). Specifically, 5 U.S.C. § 7521(a) provides that SEC ALJs may be removed by the SEC “only for good cause established and determined by the Merit Systems Protection Board on the record after opportunity for hearing before the Board.” So, if the President wanted to fire an SEC ALJ because he or she felt that it was necessary to “take Care that the Laws be faithfully executed,” he or she would be restricted in doing so. For these reasons, the Fifth Circuit found that the SEC’s proceedings were unconstitutional, vacated the SEC’s decision, and remanded the case for further proceedings consistent with its opinion.

This outcome in Jarksey, along with other recent decisions that have reined in the administrative state, suggest that with the increasingly Federalist orientation of the current judiciary, securities law practitioners should maintain a keen awareness of previous Supreme Court cases involving administrative law, especially dissents or concurrences by conservative justices. See, e.g., Gundy v. United States, 139 S. Ct. 2116, 2131, 204 L. Ed. 2d 522 (2019)(statute before the Court “scramble[d]” the Constitution’s promises “that only the people’s elected representatives may adopt new federal laws restricting liberty.”)(Gorsuch, J., dissenting); W. Virginia v. Env’t Prot. Agency, 142 S. Ct. 2587 (2022)(citing to previous dissents and relying on Justice Gorsuch’s dissent in Gundy). This is yet another challenge in knowing which way the wind will blow and how to best advise clients when the SEC comes knocking.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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