Insights

Fifth Circuit Finds SEC Administrative Proceedings Unconstitutional

Fifth Circuit Finds SEC Administrative Proceedings Unconstitutional

In a recent decision, Jarkesy v. SEC, the Court of Appeals for the Fifth Circuit ruled that important components of the SEC's enforcement regime for securities fraud cases are unconstitutional, presenting key questions about the future of administrative enforcement actions brought by the SEC and other federal agencies.

On May 18, 2022, the Court of Appeals for the Fifth Circuit ruled that key aspects of the SEC's in-house enforcement regime for securities fraud cases were unconstitutional. The decision, Jarkesy v. SEC, has significant implications for the federal securities laws, the Commission's enforcement activities, and also other agency enforcement actions across the federal government.  

Several years ago, the Commission brought an administrative proceeding against the founder of two hedge funds and the funds' investment adviser for securities fraud. After federal courts declined to enjoin the proceeding, an SEC administrative law judge ("ALJ") found the petitioners had violated the federal securities laws and imposed a civil penalty. The Commission affirmed the ALJ's decision. The petitioners appealed to the Fifth Circuit and raised several constitutional arguments.  

The Fifth Circuit agreed with three of those arguments, vacated the Commission's decision, and remanded the matter to the SEC.  

  • First, the court held that the Commission's in-house adjudication of the case violated the petitioners' Seventh Amendment right to a jury trial. The court reasoned that actions seeking civil penalties are the types of claims that arose at common law and thus implicate the constitutional right to a jury trial. The court also held the "public rights" doctrine did not permit an administrative adjudication for these sorts of actions without a jury trial.  
  • Second, the Fifth Circuit held that the Commission's statutory ability to opt to bring securities fraud actions within the agency violated the "non-delegation doctrine." The court concluded that Congress had delegated legislative power to the SEC by allowing the Commission to decide whether to bring enforcement actions in federal court or as administrative actions. The court further held that this delegation of power is unconstitutional because Congress has not provided guidance to the Commission with respect to how it should exercise that discretion.  
  • Finally, the court held that the statutory removal restrictions for SEC ALJs are unconstitutional. The court found that the ALJs were improperly insulated by at least two layers of "for cause" removal, given that the ALJs (who themselves could be removed only for cause) could only be removed by the SEC Commissioners with the approval of the Merit Systems Protection Board—both of whom also have statutory "for cause" removal protections. The court held that these layered restrictions unconstitutionally impede the President's ability to supervise the Executive Branch. 

Should the Jarkesy decision stand, it would have a number of important implications, and the government's response thus should be followed closely. Jarkesy maintains that the subject of any SEC enforcement action seeking civil penalties has a constitutional right to a jury trial in federal court. Additionally, the court's non-delegation holding would impede the Commission's ability to proceed through administrative actions generally. At least in the short term, the SEC will likely bring all litigated matters in federal district court where, unlike in administrative proceedings, the defendant has access to full discovery, and the rules of evidence apply. The decision could also suggest broader implications for administrative enforcement actions brought by other federal agencies. 

Incrementally over the decades since 1990, SEC administrative actions have changed from proceedings to sanction regulated entities and persons associated with them, to proceedings to sue, and to sanction any person for any securities law violation. It will be interesting to see if courts continue to find this administrative power has gone too far.

Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our “Contact Us” form, which can be found on our website at www.jonesday.com. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.