U.S. Supreme Court Limits Use of SEC Administrative Courts in Antifraud Actions

On June 27, 2024, the U.S. Supreme Court, in a 6–3 split, issued its highly anticipated opinion in Securities and Exchange Commission v. Jarkesy, holding that when the Securities and Exchange Commission alleges a defendant has violated an antifraud provision of the federal securities laws and seeks civil penalties in an administrative proceeding, the Seventh Amendment of the U.S. Constitution entitles the defendant to a jury trial.¹ The case stems from the appeal of a 2022 U.S. Court of Appeals for the Fifth Circuit opinion, which held that the SEC’s adjudication before an administrative law judge of antifraud claims where the Commission seeks a civil penalty violates (1) the respondent’s Seventh Amendment right to a jury trial, (2) the nondelegation doctrine based on the Commission’s unfettered discretion to choose between an administrative proceeding or federal court, and (3) the Take Care Clause of Article II of the Constitution based on statutory restrictions on the removal of SEC ALJs. The Supreme Court’s ruling addressed only the Seventh Amendment question and did not reach the other two constitutional issues.

The Jarkesy decision jeopardizes the SEC’s use of its own in-house courts in numerous cases. The Court’s opinion focused on actions alleging violations of antifraud provisions, but there are now serious questions about whether the ruling will sweep more broadly — both at the SEC and at other federal agencies with administrative enforcement powers.

Background

Jarkesy began as an SEC administrative enforcement action against George Jarkesy Jr. (pronounced “JAR-kuh-see”) and Patriot28, LLC, an investment adviser (collectively, the Respondents). The Commission alleged that the Respondents violated various antifraud provisions of the Securities Act, the Securities Exchange Act, and the Investment Advisers Act and instituted an administrative enforcement action against them. Ultimately, following an unsuccessful collateral challenge in federal court to the SEC’s administrative proceedings, the ALJ concluded that the Respondents committed securities fraud, and the Commission affirmed. The Commission imposed a civil penalty, disgorgement, a cease-and-desist order, and industry and officer-and-director bars against Jarkesy.

The Respondents appealed the Commission’s ruling to the Fifth Circuit, and that court held that the in-house adjudication of antifraud claims where the Commission seeks a civil penalty violates multiple constitutional provisions. The SEC filed a petition for a writ of certiorari, which the Supreme Court granted.

Supreme Court Decision

In an opinion written by Chief Justice John Roberts, the majority first examined the threshold issue of whether the action implicated the Seventh Amendment right to trial by jury. The Seventh Amendment guarantees the right to a jury trial for “[s]uits at common law,” which the majority explained includes statutory claims that are “legal in nature.” To determine whether a claim is legal in nature, courts consider whether the cause of action resembles common law causes of action and whether the remedy is of the sort that was traditionally obtained in a court of law. The majority expressly found that the remedy — civil penalties — is the “more important” consideration and was “all but dispositive” in the instant action. The Court held that civil penalties, a form of monetary relief the majority emphasized is designed to punish or deter the wrongdoer, is a type of remedy at common law that could be enforced only in courts of law. The majority further stated that the similarity between federal securities fraud and common law fraud (despite some differences in standard of proof and elements of the violation) confirmed that the action was “legal in nature.”

Having found that the claims implicated the Seventh Amendment, the majority next considered whether it came within the “public rights” exception, which allows Congress to assign matters to an agency without a jury consistent with the Seventh Amendment. In examining its precedent on the public rights exception, the majority remarked that “[o]ur opinions governing the public rights exception have not always spoken in precise terms” and that the Court “has not definitively explained the distinction between public and private rights,” which it declined to do in this case. But the majority explained that “[i]f a suit is in the nature of an action at common law, then the matter presumptively concerns private rights, and adjudication by an Article III court is mandatory.” Pointing to precedent, the Court concluded that SEC antifraud actions were sufficiently similar to common law fraud actions so that they involved matters of private right. In reaching that conclusion, the majority explained that the Court’s prior ruling in Atlas Roofing Co. v. Occupational Safety and Health Review Commission, 430 U.S. 442 (1977), which allowed civil penalty claims in administrative proceedings under the Occupational Safety and Health Act of 1970 for violations of new and highly detailed safety regulations, was not controlling because the claims there were “unknown to the common law” and therefore distinguishable from the fraudulent conduct claims against Respondents.

Having concluded that the Respondents were entitled to a jury trial in an Article III court, the Court affirmed the Fifth Circuit’s decision in their favor. The Court did not reach the remaining nondelegation or removal issues addressed in the earlier Fifth Circuit opinion.

Justice Neil Gorsuch (joined by Justice Samuel Alito) penned a concurring opinion, highlighting that Article III and the Due Process Clause of the Fifth Amendment operate with the Seventh Amendment to limit the government’s deprivation of an individual of life, liberty, or property and “reinforce the correctness of the Court’s course.”

In a dissenting opinion, Justice Sonia Sotomayor sharply criticized the majority’s view, arguing that the holding infringed on the separation of powers and describing its treatment of the public rights doctrine as “gerrymandered to produce today’s result.” Justice Sotomayor further lamented: “It is not clear what else, if anything, might qualify as a public right, or what is even left of the doctrine after today’s opinion.” She also suggested that the majority’s opinion could implicate the constitutionality of hundreds of statutes and dozens of agencies with powers to seek civil penalties through administrative proceedings.

The Future of Administrative Proceedings Post-Jarkesy

The Court’s decision will undoubtedly affect administrative enforcement proceedings, both at the Commission and at numerous other federal agencies. The full implications of Jarkesy will need to be worked out on a case-by-case basis in different administrative contexts.

Does Jarkesy apply only to antifraud administrative proceedings seeking penalties or to all SEC administrative proceedings seeking penalties?

The underlying SEC enforcement action in Jarkesy alleged violations of only antifraud provisions, so the Court’s opinion did not conclusively address how the Seventh Amendment or the public-rights exception may apply in cases alleging different violations or seeking different sanctions. The majority did not explicitly overrule Atlas Roofing, so there arguably may be some claims (such as registration, books and records, or financial responsibility claims) not sounding in fraud that the Commission could attempt to bring in administrative proceedings and seek civil penalties. But other claims (e.g., investment adviser marketing, custody, and compliance rules) were promulgated in part under antifraud statutes, so they are more directly at risk after Jarkesy. In fact, the majority’s discussion of Atlas Roofing — whose continuing viability appears very much in doubt — raises the question of whether all penalty claims in administrative proceedings could implicate the Seventh Amendment jury right. This may be especially true for claims that the Commission is authorized to bring both administratively and in federal court (with the major exception being SEC Rule 102(e) claims against accountants, lawyers, and other professionals, which can be brought only in administrative proceedings).

As a practical matter, in part because of the pending challenges like those in Jarkesy, the SEC has in recent years brought almost all litigated proceedings in federal court. In light of Jarkesy, the SEC very well may continue this practice for any litigated claims where it is authorized to bring the claim in court, not just antifraud claims, to avoid additional litigation risk.

Does the ruling bar the SEC from seeking penalties in settled antifraud administrative proceedings?

Although the Court did not address the SEC’s ability to settle cases administratively with the parties agreeing to a civil penalty (as opposed to litigating them before an ALJ), it seems clear that settling defendants can agree to penalty amounts and waive their right to a jury trial as part of a settled administrative resolution.

Would Jarkesy apply to antifraud administrative proceedings in which the SEC is not seeking civil money penalties (i.e., disgorgement, cease and desist, etc.)?

This remains an open question, as the majority’s holding was limited to antifraud actions in which the Commission seeks civil penalties. There is an argument that the SEC could bring actions seeking other remedies administratively, given the majority’s focus in its opinion on the punitive aspects of civil penalties as contributing to the actions being legal in nature. In Liu v. SEC, the Court held that disgorgement is an equitable remedy authorized by the federal securities law, at least in those cases where the disgorgement can be paid to harmed investors. But in Kokesh v. SEC, the Court held that disgorgement awards at times can operate as a penalty, for the purposes of the application of the statute of limitations. How the Court will analyze disgorgement for Seventh Amendment purposes is yet to be determined.

Nonetheless, as a practical matter, the SEC routinely seeks penalties in antifraud actions (as well as in virtually all other enforcement actions under any of its statutes), so any such proceedings limited only to equitable remedies may be unlikely to occur in any event.

Would Jarkesy apply to administrative proceedings brought by other administrative agencies?

The rationale of Jarkesy could have far-reaching implications beyond the SEC. The Court, both at oral argument and in its opinion, considered the implications of requiring a jury trial, and thus precluding administrative proceedings, in all administrative agency adjudications. The majority opinion distinguished cases involving tariffs, immigration, pensions and other government benefits, public lands, and patents as involving true “public rights,” and it declined to overrule Atlas Roofing, which permitted the Occupational Safety and Health Administration to impose administrative penalties for workplace safety violations — though a long footnote seemed to cast substantial doubt on that precedent. Moreover, the majority did not distinguish the more than two dozen federal agencies cited by the dissent as potentially losing their statutory authority to bring administrative proceedings — and some of those agencies have only administrative enforcement authority with no recourse to federal courts. Absent congressional action, depending on how future courts apply Jarkesy, those agencies may be foreclosed from enforcing statutes and regulations they administer.

In short, Jarkesy promises to be only the beginning of litigation about the applicability of the Seventh Amendment to administrative proceedings, not only at the SEC but across the federal government.

¹ The opinion is available here.