Washington, D.C. (June 28, 2024) - The Supreme Court issued a landmark ruling on June 27, 2024 that significantly curtails the powers of the Securities and Exchange Commission ("SEC") and has far-reaching implications for administrative law judges ("ALJs") across the federal government. In a 6-3 decision in SEC v. Jarkesy, No. 22-359 (2024) the Court held that when the SEC seeks to impose civil penalties for securities fraud, defendants have a constitutional right to a jury trial in federal court rather than an administrative proceeding before an SEC ALJ.
The case originated from an SEC enforcement action against hedge fund manager George Jarkesy, Jr., and his firm, Patriot28, LLC. Between 2007 and 2010, Jarkesy launched two investment funds, raising approximately $24 million from 120 accredited investors. The SEC alleged that Jarkesy and Patriot28 misled investors by misrepresenting investment strategies, lying about the funds' auditor and prime broker, and inflating the funds' claimed value to collect larger management fees. SEC v. Jarkesy, No. 22-359, slip op. at 4-5.
The majority opinion, authored by Chief Justice John Roberts, found that the SEC's practice of adjudicating fraud cases and imposing civil penalties through agency administrative proceedings violates the Seventh Amendment right to a jury trial. Id. at 7. The Court reasoned that the "the Seventh Amendment extends to a particular statutory claim if the claim is legal in nature." Id. at 8. Further, "what determines whether a monetary remedy is legal is if it is designed to punish or deter the wrongdoer, or, on the other hand, solely to restore the status quo." Id. at 9. Thus, the money damages that the SEC sought are designed to punish and deter, not to compensate. Id. at 11 ("In sum, the civil penalties in this case are designed to punish and deter, not to compensate. They are therefore "a type of remedy at common law that could only be enforced in courts of law").
The Court rejected the SEC's argument that these cases fall under the "public rights" exception, citing its decision in Granfinanciera, S.A. v. Nordberg, which allows certain matters to be decided by administrative agencies without a jury. Slip Op. at 18. There, the case involved a statutory action for fraudulent conveyance under the language of the Bankruptcy Code that did not exist under the common law. Id. at 19. The Court held that "[w]hat mattered, we explained, was the substance of the suit. Traditional legal claims – that is, those types of claims that arise under the common law – must be decided by courts, "whether they originate in a newly fashioned regulatory scheme or possess a long line of common-law forebears." Id.
Importantly, the Court distinguished Jarkesy from Atlas Roofing Co. v. Occupational Safety and Health Review Comm'n, which had previously allowed certain administrative adjudications without jury trials. Atlas Roofing Co. v. Occupational Safety and Health Review Comm'n, 430 U.S. 442 (1977). The Court explained that Atlas Roofing involved "a new cause of action, and remedies therefor, unknown to the common law," whereas the SEC's fraud claims are "'in the nature of' a common law suit." SEC v. Jarkesy, slip op. at 24-25 (2024) (quoting Atlas Roofing, 430 U.S. at 461, 453). The Court further clarified that Atlas Roofing does not apply here because "Jarkesy and Patriot28 were prosecuted for 'fraudulent conduct,' and the pertinent statutory provisions derive from, and are interpreted in light of, their common law counterparts." Id. at 25.
Chief Justice Roberts emphasized that "A defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator." Slip op. at 6. Moreover, "when a matter 'from its nature, is the subject of a suit at the common law,' Congress may not 'withdraw [it] from judicial cognizance." Id. at 27 (quoting Murray's Lessee v. Hoboken Land & Improvement Co., 18 How. 272, 284 (1856)). To the contrary, the majority ruled, fraud cases seeking civil penalties are analogous to traditional common law fraud claims that require a jury trial. Slip Op. at 8-13, 20-21.
Resting squarely on Constitutional grounds – "Congress cannot 'conjure away the Seventh Amendment by mandating that traditional legal claims be...taken to an administrative tribunal,'" Id. at 21 (quoting Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 52 (1989)) – the decision overturns decades of practice at the SEC and other federal agencies that have created internal adjudication systems under ALJs and other types of hearing officers to arbitrate enforcement actions and impose civil penalties. As was highlighted in the briefs, the majority's reasoning in Jarkesy extends beyond just the SEC to other agencies that use ALJs to adjudicate cases involving civil penalties.
In a strongly worded dissent joined by Justices Elena Kagan and Ketanji Brown Jackson, Justice Sonya Sotomayor warned of the "momentous consequences" of the majority's ruling, noting that "more than two dozen federal agencies that can impose civil penalties in administrative proceedings." SEC v. Jarkesy, (Dissent), slip op. at 33, 34. She argued this decision "means that the constitutionality of hundreds of statutes may now be in peril, and dozens of agencies could be stripped of their power to enforce laws enacted by Congress." Slip Op. at 35. She pointed out that while some agencies, like the Consumer Financial Protection Bureau, Environmental Protection Agency, Federal Trade Commission, and SEC can pursue civil penalties in both administrative proceedings and federal court, others, such as the Occupational Safety and Health Administration, the Federal Energy Regulatory Commission, Mine Safety and Health Administration, and Department of Agriculture operate under statutes that allow civil penalties only in agency enforcement proceedings. Id. at 35.
The full impact of this decision remains to be seen, but what Justice Sotomayor characterized as a "seismic shift," Id. at 33, is likely to significantly reshape the way federal agencies conduct enforcement actions. For those agencies that can bring actions for civil penalties in court, a surge of cases diverted from proceedings before ALJs can be expected, straining judicial resources. Those agencies left without an internal civil penalty remedy will likely be the subject of efforts in Congress to amend their governing statutes. In the meantime, regulated businesses will need to look carefully at the far-reaching implications of the Jarkesy decision for pending and future federal agency action affecting their interests.
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