Supreme Court Curtails SEC In-House Judges on Litigated Civil Penalties

In SEC v. Jarkesy, the Supreme Court held that the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties for securities fraud. The decision bars the SEC from bringing such an action in an administrative forum and will have broader implications by narrowing the circumstances where the SEC and other departments and agencies may require defendants to litigate before administrative fora. The Court’s holding should not disrupt the SEC’s ability to obtain penalties in settled administrative proceedings where the settling party consents to the penalty and waives its right to a jury trial. Dechert LLP filed an amicus brief in support of Jarkesy on behalf of the Chamber of Commerce of the United States of America.

Background

The Dodd-Frank Wall Street Reform and Consumer Protection Act expanded the SEC’s authority to seek civil penalties in securities enforcement actions before administrative law judges (“ALJs”), as well as in federal court.¹  When the SEC proceeds administratively, there is no jury.²  Instead, an ALJ appointed by the SEC presides over these “in-house proceedings.”³

Shortly after Dodd-Frank’s passage in 2010, the SEC charged George Jarkesy, Jr., and his investment firm, Patriot 28, LLC with fraud under the federal securities laws. The SEC sought civil penalties in its administrative proceedings.⁴  After a hearing before an ALJ, the SEC levied a US$300,000 civil penalty against Jarkesy and Patriot28.⁵  On a petition for review, the Fifth Circuit held that the SEC proceeding violated three separate constitutional constraints: the Seventh Amendment, the nondelegation doctrine, and Article II.⁶  The Supreme Court granted certiorari and affirmed.

The Supreme Court’s Decision

Without reaching the latter two constitutional grounds, the Supreme Court held that the Seventh Amendment entitles defendants like Jarkesy to a jury trial where the SEC seeks civil penalties for securities fraud. The Seventh Amendment guarantees that in “[s]uits at common law, . . . the right of trial by jury shall be preserved.”⁷  In a majority opinion authored by the Chief Justice, the Court built on Granfinanciera, S. A. v. Nordberg,⁸  and Tull v. United States.⁹  Those cases had held that the Seventh Amendment applies to all claims that resemble actions brought in common-law courts, as compared with courts of equity or admiralty. In Jarkesy, the Court focused first and foremost on the remedy sought, concluding that the SEC’s pursuit of a civil penalty was “all but dispositive.”¹⁰  As the Court had recognized in Tull, an action by the government for civil penalties was traditionally understood to seek a legal, not an equitable, remedy. Although a court of equity could order disgorgement to restore the status quo, only courts of law could impose financial penalties to deter and punish a culpable party.¹¹  Because civil penalties were essentially a legal remedy, the Court held that the Seventh Amendment must apply.¹²  In addition, the Court emphasized that “[t]he close relationship between the causes of action in this case,” i.e., alleged securities fraud “and common law fraud,” reinforced the Court’s conclusion.¹³

In reaching this conclusion, the Court rejected the Solicitor General’s request that the Court apply the “public rights” exception to the Seventh Amendment. Under that exception, “Congress may assign [a] matter for decision to an agency,” instead of a federal court, “without a jury, consistent with the Seventh Amendment.”¹⁴  Tracing the public rights exception back to the 1856 precedent of Murray’s Lessee v. Hoboken Land & Improvement Co.,¹⁵  the Court explained that a claim must fall within a “historic categor[y] of adjudications” to qualify for the public rights exception.¹⁶  Those categories included the determination of tax liability, immigration status, or governmental benefits, yet no such tradition applied here. Nor did the mere fact that the Government had brought the suit under a federal law carry the case into the public rights category: “what matters is the substance of the suit, not where it is brought, who brings it, or how it is labeled.”¹⁷

In reaching this conclusion, the Court rejected, and effectively narrowed, Atlas Roofing Co. v. Occupational Safety and Health Review Commission.¹⁸  In Atlas Roofing, a divided Court had held that the Occupational Safety and Health Review Commission could enforce alleged violations of the OSH Act through in-house agency adjudications. “Unlike the claims in Granfinanciera and [Jarkesy], the OSH Act did not borrow its cause of action from the common law,” but instead involved claims that “were ‘unknown to the common law.’”¹⁹

In a concurring opinion joined by Justice Thomas, Justice Gorsuch agreed with the Court’s Seventh Amendment holding and added that the Fifth Amendment’s Due Process Clause and Article III also compelled the same result. Those constitutional provisions reinforced the rights of defendants to receive fair and impartial hearings in suits brought by the government.

Justice Sotomayor, joined by Justice Kagan and Justice Jackson, dissented and would have held that Congress could empower agencies to adjudicate civil violations of statutes without a jury.

Practical Implications

The SEC knew this day would come. In light of prior constitutional challenges regarding SEC administrative proceedings, the SEC has been filing its contested actions in federal district court and likely will continue this practice going forward. Jarkesy might, however, render the SEC more willing to settle certain cases rather than take them in front of a jury in federal district court—especially technical cases lacking much jury appeal. As Justice Gorsuch pointed out in his concurrence: “According to one report, during the period under study the SEC won about 90% of its contested in-house proceedings compared to 69% of its cases in court.”²⁰  And the Court’s holding places no restriction on the SEC’s ability to enter into settled administrative proceedings with parties who consent to civil penalties and waive their jury trial right.²¹

Jarkesy’s impact is not limited to the SEC. It will likely have significant influence on other administrative agencies with similar in-house tribunals, such as the U.S. Department of Labor or the Consumer Financial Protection Bureau, that can also seek civil penalties or monetary remedies.

The Jarkesy Court also made clear that just because a claim arises under a federal statute like the securities laws, the Government cannot assign adjudication of that claim to an administrative agency if the claim sounds in the common law.²²  Because the Court focused upon the civil penalties of the antifraud provisions, it did not decide whether other claims or other remedies available under the federal securities laws are sufficiently analogous to actions at common law to require trial by jury. The Court emphasized the importance of the remedy sought, noting that the legal nature of civil penalties was “all but dispositive” and approvingly quoted a precedent framing the remedy as the critical consideration in distinguishing actions at law from those sounding in equity.²³  The similarities between the underlying statutory fraud action and common law fraud merely served to “confirm[]” the Court’s Seventh Amendment conclusion.²⁴

Of note, the Supreme Court’s decision did not address the Fifth Circuit’s holding that the SEC’s ALJs are improperly insulated from removal in violation of the President’s authority under Article II.²⁵  With this cloud still hanging over its head, it remains unclear how the SEC will address potential relief that can be pursued only through an administrative proceeding (e.g., Rule 102(e) bars or suspensions against accountants and attorneys who practice before the SEC). The Fifth Circuit’s conclusion about the structure of ALJs remains the law in the Fifth Circuit, and it is likely to be an issue that will recur and return to the Supreme Court in a future case.

Conclusion

As with the Fifth Circuit’s ruling, discussed in our previous OnPoint, Jarkesy returns the SEC to the pre-Dodd Frank enforcement regime, at least in litigated cases seeking civil penalties for securities fraud. Because it will not always be self-evident whether a federal agency’s enforcement action sounds in law or in equity, we can expect that there will be many future challenges in which the federal courts will need to define the boundaries of the Seventh Amendment, as it applies with respect to administrative enforcement actions.