In a 6-3 decision, the US Supreme Court on June 27, 2024, in Securities and Exchange Commission v. Jarkesy held that the Seventh Amendment of the US Constitution entitles a defendant to a jury trial when the US Securities and Exchange Commission (SEC or Commission) seeks civil penalties for securities fraud, and thus that the SEC may not seek such penalties through its own “in-house” administrative enforcement proceedings, which lack juries. Instead, the SEC may pursue such penalties only in federal court.
The Court’s decision is likely to make permanent the SEC’s more recent practice of bringing such litigated cases in federal court, rather than in its “in-house” administrative proceedings. The decision is unlikely, however, to impact the SEC’s and parties’ ability to voluntarily settle a matter as an administrative proceeding after an enforcement investigation, even if that settlement involves a penalty.
Pursuant to its enabling legislation, the SEC may bring an enforcement action in one of two forums: it may “adjudicate the matter itself,” or it may “file a suit in federal court.” [1] The SEC’s choice of forum dictates the “procedural protections enjoyed by the defendant” and the remedies available to the SEC.” [2]
In federal court, “a jury finds the facts, depending on the nature of the claim,” an “Article III judge presides,” and “the litigation is governed by the Federal Rules of Evidence and the ordinary rules of discovery.” [3] By contrast, when the SEC adjudicates a matter “in-house,” “there are no juries.” [4] Instead, the Commission (or an administrative law judge (ALJ) appointed by the Commission) presides, finds facts, “decides discovery disputes,” “determines the scope and form of permissible evidence,” and “may admit hearsay and other testimony that would be inadmissible in federal court.” [5]
The remedies available to the SEC also historically depended on whether the suit was adjudicated in-house or in federal court. Civil penalties, including fines “up to $725,000 per violation,” “rank among the SEC’s most potent enforcement tools.” [6] With limited exceptions, originally the SEC “could obtain civil penalties only in federal court.” [7]
In 2010, however, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) which made the SEC’s authority to seek civil penalties in in-house administrative proceedings “coextensive with its authority to seek penalties in Federal court.” [8] In other words, after the passage of the Dodd-Frank Act, the SEC could “seek civil penalties in federal court” or “impose them through its own in-house proceedings,” even though those proceedings lack juries.[9]
As we previously discussed, on April 14, 2023, the US Supreme Court in Axon Enterprise Inc. v. Federal Trade Commission unanimously decided that a party may bring constitutional challenges to the SEC’s use of ALJs in its in-house proceedings without first litigating the proceeding to its conclusion. [10]
In a concurring opinion in Axon, Justice Clarence Thomas expressed “grave doubts” about the constitutionality of in-house proceedings, determined that private rights may be adjudicated and divested only by Article III courts, and opined that the civil penalties sought by the SEC in that case “implicate the core private right to property.” [11] The Axon Court, however, did not rule on the constitutionality of agencies’ use of ALJs or “in-house” administrative enforcement proceedings.
Between 2007 and 2010, George Jarkesy, Jr. launched two investment funds, raising approximately $24 million from investors. [12] Patriot28 LLC, which Jarkesy managed, served as the funds’ investment advisor. [13] According to the SEC, Jarkesy and Patriot28 misled investors by (1) misrepresenting the funds’ investment strategies, (2) lying about the identity of the funds’ auditor and prime broker, and (3) inflating the funds’ claimed value so that they could collect larger management fees. [14]
In 2013, the SEC initiated an enforcement action against Jarkesy and Patriot28, seeking civil penalties for alleged violations of the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940. [15] The SEC chose to adjudicate the matter in-house before an ALJ. [16] In 2014, the presiding ALJ issued an initial decision. It then took the SEC six years to review that initial decision and release its final order in 2020, levying a civil penalty against Jarkesy and Patriot28 for $300,000, among other relief.
A divided panel of the US Court of Appeals for the Fifth Circuit vacated the final order on the grounds that the agency’s decision to adjudicate the matter in-house violated Jarkesy’s and Patriot28’s Seventh Amendment right to a jury trial. Applying the two-part test set out in Granfinanciera, S.A. v. Nordberg, 492 US 33 (1989), the court held that (1) because the SEC’s antifraud claims were “akin to [a] traditional action[] in debt,” a jury trial would be required if the case were brought in federal court, and thus the Seventh Amendment’s jury-trial right applied, and (2) the “public rights” exception, which “permits Congress, under certain circumstances, to assign an action to an agency tribunal without a jury,” did not apply, “and that therefore the case should have been brought in federal court, where a jury could have found the facts pertinent to the defendants’ fraud liability.” [17]
In a 6-3 decision authored by Chief Justice John Roberts, the Supreme Court agreed with the Fifth Circuit’s two-part analysis.
First, the Court held that the SEC’s action against Jarkesy implicated the Seventh Amendment’s right to a jury trial because the SEC’s antifraud provisions “replicate common law fraud, and it is well established that common law claims must be heard by a jury.” [18]
Specifically, the Court held that the Seventh Amendment extends to statutory claims that are “legal in nature,” and that civil penalties like those the SEC seeks to impose on Jarkesy—which “are designed to punish and deter, not to compensate”—are a “remedy at common law that could only be enforced in courts of law.” [19]
The Court noted that the “close relationship between federal securities fraud and common law fraud confirms that the action is legal in nature,” and therefore concluded that the SEC’s suit “implicates the Seventh Amendment” and that Jarkesy was “entitled to a jury on [the] claims.” [20]
Second, the Court held that the “public rights” exception to the Seventh Amendment’s jury-trial right does not apply because the SEC’s action against Jarkesy “does not fall within any of the distinctive areas involving governmental prerogatives where the Court has concluded that a matter may be resolved outside of an Article III court, without a jury.” [21]
The Court explained that “matters concerning private rights may not be removed from Article III courts,” and if 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.” [22]
Because the SEC’s claims against Jarkesy arise under the “antifraud provisions of the federal securities laws,” “provide civil penalties” that “could only be enforced in courts of law,” and “target the same basic conduct as common law fraud, employ the same terms of art, and operate pursuant to similar legal principles,” the SEC’s action against Jarkesy “involves a matter of private rather than public right” and therefore “Congress may not withdraw it from judicial cognizance.” [23]
The Jarkesy decision is unlikely to significantly change the SEC’s current approach to actions seeking civil penalties for securities fraud. As Justice Neil Gorsuch recognized in his concurring opinion in Axon, SEC in-house proceedings are heavily “tilted” in the SEC’s favor: “[f]rom 2010 to 2015, the SEC won 90% of its contested in-house proceedings compared to 69% of the cases it brought in federal court.” [24] In response, many respondents challenged the constitutionality of the SEC’s administrative proceedings in federal court. To avoid such challenges, for years, the SEC’s practice has been to pursue securities fraud cases in federal court. The Jarkesy decision is likely to make that practice permanent.
While it remains to be seen whether Jarkesy will be extended to non-fraud actions arguably implicating respondents’ property rights, the Jarkesy decision may not affect the SEC’s ability to use administrative proceedings in fraud cases in which the SEC seeks only disgorgement (i.e., requiring the respondent to return ill-gotten funds).
That said, the SEC is unlikely to bring fraud claims administratively if it has to forgo seeking a civil money penalty—one of the strongest tools in its arsenal. The decision also does not affect the use of administrative proceedings in SEC enforcement actions on claims not arising from the common law, such as books and records violations or violations for failure to supervise.
In any event, the SEC will need to determine if bringing litigated cases without any threat of a civil money penalty is a worthy use of its limited resources. Furthermore, the Jarkesy decision should not prohibit parties from electing to settle matters involving a financial penalty administratively. This is because parties are generally free to waive constitutional rights, and in fact, SEC offers of settlement virtually always contain such a waiver. [25]
The Jarkesy decision could also impact the extent to which other federal agencies may conduct “in-house” enforcement proceedings without juries, particularly when those agencies seek to pursue claims founded in the common law or impose civil penalties designed to deter the wrongdoer.
Justice Sonia Sotomayor noted in her dissenting opinion, joined by Justices Elena Kagan and Ketanji Jackson, that Congress “has enacted more than 200 statutes authorizing dozens of agencies to impose civil penalties for violations of statutory obligations,” and warned of “chaos” that the majority opinion “would unleash” on these agencies. [26] She further criticized the majority’s attempt to limit the power of the many government agencies that are legislatively enabled to impose civil penalties only through administrative proceedings, not in court. [27]
Finally, the Court in Jarkesy did not address the Fifth Circuit’s determinations that (1) “Congress had violated the nondelegation doctrine by authorizing the SEC, without adequate guidance, to choose whether to litigate this action in an Article III court or to adjudicate the matter itself,” and (2) “insulation of the SEC ALJs from executive supervision with two layers of for-cause removal protections violated the separation of powers.” [28]
Rulings on these issues would have had a far broader impact beyond fraud cases seeking civil penalties. For instance, the decision also leaves open the question of whether the SEC can bring an action to prevent someone from appearing as an accountant or lawyer before the SEC. These actions can only be brought administratively, but Justice Gorsuch’s concurrence suggests this practice may be in jeopardy given that these cases seek to prevent an individual from pursuing their chosen livelihood without a jury deciding their fate. [29]
Future decisions by the Court on these matters may further erode federal agencies’ authority to conduct “in-house” enforcement proceedings. Given that these, and other constitutional challenges, remain undecided, the SEC may continue to forgo bringing most contested matters administratively until courts provide further clarity in matters involving other agencies.
Summer associate Fiona Fitzgerald contributed to this LawFlash.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following:
[1] Sec. & Exch. Comm’n v. Jarkesy, No. 22-859, 2024 WL 3187811, at *5 (U.S. June 27, 2024).
[2] Id.
[3] Id.
[4] Id.
[5] Id.
[6] See id. at *6 (citing 15 U.S.C. §§ 77h-1(g), 78u-2, 80b-3(i)).
[7] Id.
[8] H. R. Rep. No. 111-687, p. 78 (2010).
[9] 15 U.S.C. §§ 77h-1(g), 78u-2(a), 80b-3(i)(1)).
[10] Axon Enter., Inc. v. Fed. Trade Comm'n, 598 U.S. 175, 180 (2023).
[11] Id. at 196, 204.
[12] Jarkesy, 2024 WL 3187811, at *6.
[13] Id.
[14] Id.
[15] 48 Stat. 74, 15 U. S. C. §§ 77a, et seq.; 48 Stat. 881, 78a et seq.; 54 Stat. 847, 80b–1 et seq.
[16] Jarkesy, 2024 WL 3187811, at *4.
[17] Id. at *6.
[18] Id. at *7.
[19] Id. at *8-9.
[20] Id.
[21] Id. at *7.
[22] Id. at *10.
[23] Id. at *14 (internal citations, quotation marks, and alterations omitted).
[24] Axon, 598 U.S. at 215.
[25] See Sec. & Exch. Comm'n v. Romeril, 15 F.4th 166, 172–73 (2d Cir. 2021).
[26] Jarkesy, 2024 WL 3187811, at *30.
[27] Id. at *45.
[28] Id. at *7.
[29] Id. at *17-29.