On May 18, 2022, the US Court of Appeals for the Fifth Circuit issued its decision in Jarkesy v. SEC, vacating a Securities and Exchange Commission (SEC) decision in an enforcement action brought as an administrative proceeding, on the grounds that the proceeding suffered from constitutional defects. This decision has raised important questions about the ability of federal agencies to enforce the law in their own internal hearings before administrative law judges (ALJs).
Section 929P(a) of the Dodd-Frank Act empowered the SEC to bring securities fraud actions for monetary penalties either in its own administrative forum, presided over by an ALJ and without a jury, or in a traditional federal court established under Article III of the Constitution. The SEC in 2013 brought a securities fraud enforcement action against George Jarkesy and his firm in the SEC’s internal administrative forum. The ALJ ruled against Jarkesy, and this decision was affirmed by the SEC. Jarkesy then appealed to the Fifth Circuit, which vacated the SEC’s decision as unconstitutional for three reasons: 1) bringing the enforcement action in the SEC’s administrative forum violated Jarkesy’s Seventh Amendment right to a jury trial, 2) authorizing the SEC to either bring an enforcement action to its own administrative forum or an Article III court without providing the SEC with any guidance on how to make that election was an unconstitutional delegation of Congress’s power, and 3) the ALJs who preside over the SEC’s administrative proceedings are unconstitutionally insulated from presidential oversight in violation of the Constitution’s “take care” clause. The Fifth Circuit reasoned as follows:
Seventh Amendment Jury Trial Right
The Seventh Amendment of the US Constitution guarantees the right to a jury trial in civil cases in federal court where the amount in dispute is over $20, and the Supreme Court long ago held that government enforcement actions seeking monetary penalties are the type of action to which the jury trial right applies. While Congress can authorize an administrative agency to adjudicate a claim where the government is suing to enforce a statutory “public right,” as opposed to a traditional private right in tort, contract or property law, the Fifth Circuit held that Jarkesy’s Seventh Amendment jury trial right was violated because the SEC’s claims did not concern public rights alone. Rather, the enforcement action involved a traditional common law claim (fraud) and sought a remedy (monetary penalty) to which the jury trial right applies. In those circumstances, the Fifth Circuit concluded that it is a violation of the Seventh Amendment to bring the action in an administrative forum.
Delegation of Legislative Power
Because Congress is not allowed to give up or transfer “essential legislative functions” conferred on it by the Constitution, the Supreme Court has held that Congress can only delegate regulatory power to another agency if it provides an “intelligible principle” or guidance that allows the agency to only exercise executive power when using this authority. The Fifth Circuit held that Congress unconstitutionally delegated legislative power to the SEC without an intelligible principle when it gave the SEC exclusive authority and absolute discretion to decide whether to bring an enforcement action within the agency or in an Article III court. Importantly, in footnote nine of the opinion, the court noted that while this issue constituted an alternative holding, the Fifth Circuit follows the rule that alternative holdings are binding precedent.
Statutory Removal Restrictions for SEC ALJs
Under Article II, Section 3 of the Constitution, the President has the obligation to “take care” that the laws are faithfully executed. In order to enable the President to have sufficient control over those performing substantial executive functions, the Supreme Court has held that it is unconstitutional for employees who are sufficiently important to executing laws (i.e., “inferior officers”) to be protected from removal from their roles by two layers of “for-cause” protection. In other words, it is unconstitutional for Congress to shield an inferior officer from the President’s control by providing that both that officer and his or her superior can only be removed from office by the President upon a showing of cause. Because ALJs can only be removed for cause by the joint action of SEC Commissioners and members of the Merit Systems Protection Board (MSPB), and SEC Commissioners and members of the MSPB can only be removed by the President with cause, the Fifth Circuit held that these restrictions are unconstitutional.
Enforcement Ramifications of Jarkesy v. SEC
Following the 2018 US Supreme Court decision in Lucia v. SEC, which held that the SEC had been using an unconstitutional process to appoint its ALJs, the SEC scaled back the use of the administrative forum for certain litigated matters, including matters for which a penalty was sought. As a result, while the SEC may seek to overturn Jarkesy, the ruling is not likely to affect the SEC’s enforcement approach in the near future. However, Jarkesy’s reasoning could be used to challenge the adjudicative proceedings of other agencies that are more reliant on their administrative forums, like the Federal Trade Commission or the Office of the Comptroller of the Currency. A successful constitutional challenge like the one brought in Jarkesy could vacate their recent decisions and relegate their ALJs to a much smaller role.
When the Fifth Circuit in Jarkesy discussed which enforcement actions adjudicated public rights, and therefore were not covered by the Seventh Amendment’s right to a jury trial, it looked for cases “uniquely suited for agency adjudication.” The Fifth Circuit reasoned that, as Article III courts are familiar with securities statutes, and as securities fraud actions against nonregistered parties were once required to be brought in Article III courts, there is no reason to believe that Jarkesy’s case was uniquely suited for the SEC’s internal court. This is a high bar for any enforcement action to reach and could result in both an expansion of the Seventh Amendment jury trial right and a reduction in the use of administrative courts.
Finally, the rationale of Jarkesy could transfer to other federal agencies. For instance, any agency that uses the same removal procedure as the SEC for ALJs could have their decisions vacated on the same ground as Jarkesy. This could leave many current enforcement action rulings—and those decided before an agency’s ALJ removal procedure can be amended—vulnerable.
