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SCOTUS limits the SEC’s enforcement power

7/1/24

By: William R. Covino and Nancy M. Reimer

On June 27, 2024, the Supreme Court of the United States (“SCOTUS”) issued its decision in Sec. & Exch. Comm’n v. Jarkesy, U.S., No. 22-859, 2024 WL 3187811 (June 27, 2024), affirming the Security and Exchange Commission violated George Jarkesy and Patriot28’s right to a trial by jury under the Seventh Amendment of the United State Constitution by adjudicating various anti-fraud claims and seeking civil penalties in-house.

In March of 2013, the Securities and Exchange Commission (“SEC”) brought claims against Mr. Jarkesy and Patriot28 for purportedly defrauding investors. It alleged between 2007 and 2010, Mr. Jarkesy launched two investment funds and misled investors by: (i) misrepresenting the investment strategies he and Patriot28 employed; (ii) lying about the identity of the funds’ auditor and prime broker; and (iii) inflating the funds’ claimed value to collect larger management fees.

In accordance with Congress’ Dodd-Frank Act, the SEC opted to handle this matter in its own adjudicatory system in lieu of seeking relief in Federal Court. There is little mystery as to why it chose this path. Unlike cases litigated in Federal Court with a life-tenured, salary protected Article III judge; a jury of one’s peers; a right to robust discovery and evidentiary safeguards provided by the Federal Rules of Evidence, SEC administrative proceedings are handled differently. The SEC effectively opens, prosecutes, determines, and reviews these matters on appeal.

As is often the case, the SEC assigned an administrative law judge (“ALJ”) to resolve this matter. The ALJ, employed by the SEC, was to rule on discovery requests, determine the date of the hearing, and—with a jury out of the picture—resolves both issues of law and fact. The right to challenge her factual findings on appeal was limited, and highly deferential (e.g., factual findings are “conclusive” if sufficiently supported by the record). The SEC’s Enforcement Division took full advantage of its “home court advantage.” It disclosed between 15 to 25 million pages of information to Mr. Jarkesy, and despite his protests it would take “two lawyers or paralegals working twelve-hour days over four decades to review,” the ALJ provided him ten months to prepare for the hearing. As expected, the ALJ found against Mr. Jarkesy and the SEC affirmed the ruling. A divided Fifth Circuit vacated this order and SCOTUS granted certiorari.

The sole issue SCOTUS reviewed was whether the Seventh Amendment to the United States Constitution entitles a defendant to a jury trial when the SEC seeks civil penalties for securities fraud. In a 6-3 decision (dissented by Sotomayor, Kagan, and Jackson), SCOTUS affirmed the Seventh Amendment applied to this matter. After discussing the history and policy rationales for ensuring Americans receive a trial by jury, as well as the creation of the SEC and suite of laws designed to combat securities fraud, it explained the Seventh Amendment’s guarantee of a trial by jury in “[s]uits at common law,” was intended to apply expansively.

The Seventh Amendment to the United States Constitution was to embrace “all suits which are not of equity or admiralty jurisdiction” and extends to a statutory claim if the claim is “legal in nature.” This is determined by considering “the cause of action and the remedy it provides.” In short, it does not matter where the cause of action originates (by Congress or otherwise), but the substance of the action is determinative of whether the Seventh Amendment will apply.

In this case, SCOTUS found the remedy sought by the SEC of monetary damages was “all but dispositive” because they are the prototypical common law remedy. Historically, only courts of law would issue monetary penalties to punish culpable individuals and the SEC’s decision to impose civil penalties was to punish offenders. This was evidenced by the following facts: (i) under the Securities Exchange Act and Investment Advisers Act the ability to obtain civil penalties is tied to concerns of culpability, deterrence, and recidivism; (ii) these Acts establish “tiers” of civil penalties based on the culpability of a defendant and need for deterrence; and (iii) the SEC is not obligated to return any of the money it receives in civil penalties to victims (i.e., it does not “restore the status quo” to make some pretense of being equitable).

SCOTUS further reasoned the close relationship between the causes of action in this case and the common law fraud (one allowing a trial by jury) confirmed its conclusion. Both target the same misconduct: misrepresenting and concealing material facts. Indeed, Congress drew upon common law fraud in creating the federal securities fraud law.

In rendering this ruling, SCOTUS rejected the contention Congress was allowed to empower the SEC to resolve fraud-based claims and seek monetary fees internally without a trial by jury pursuant to the “public rights” exception. While this exception allows the legislative branch to empower the executive branch to resolve certain disputes, it applies narrowly. It has only been allowed in certain categories of matters defined and limited by history, including the “collection of revenue, customs enforcement, immigration, and the grant of public benefits.”

Given what has likely created a seismic shock for the SEC, it presently remains unclear how this decision will impact federal agencies who Congress empowered to convene administrative hearings and impose monetary sanctions. These agencies include, among others, the Department of Agriculture, Department of Justice, Department of Insurance, Consumer Financial Protection Bureau, the Federal Energy Regulatory Commission, Department of Education, Environmental Protection Agency, Federal Communications Commission, and the Department of Transportation. These agencies may pass new internal rules allowing litigants to remove their administrative cases to federal court or may be more cautious in asserting them because of the cost associated with litigating matters in federal courts. Regardless, one observation is for certain: the “administrative state” in the United States has been weakened and the right to a trial by jury has been expanded.

For more information on this topic, please contact William R. Covino at William.Covino@fmglaw.com, Nancy M. Reimer at Nancy.Reimer@fmglaw.com, or your local FMG relationship partner.