The United States Supreme Court recently granted Certiorari in a closely watched case that could have significant consequences for the Securities and Exchange Commission (SEC) and certain other federal administrative agencies.
In SEC v. Jarkesy, the Supreme Court will determine the constitutionality of the SEC’s broad discretion in deciding which cases will be tried to an SEC administrative law judge (ALJ) and which will be tried to a jury in an Article III federal court. It will also consider the constitutionality of Congress’ delegation of certain authority to the SEC relating to rules and regulations that the SEC has considered or adopted, and the SEC’s discretionary authority to make determinations on policy matters where Congress has not provided sufficient guidance. The Court also will consider the constitutionality of the rules on removal of administrative law judges.
In May of 2022, the Fifth Circuit Court of Appeals, in a 2-to-1 panel opinion, determined that the SEC’s current discretionary authority to bring civil fraud claims before its in-house administrative law judges in civil-enforcement proceedings is unconstitutional in three separate ways. First, the appeals court held that the use of administrative tribunals for enforcement of common law claims which are not public claims violates the Seventh Amendment right to a jury trial. Second it found that Congress violated the non-delegation doctrine in giving the SEC broad discretion to determine whether and when to prosecute enforcement proceedings before its own ALJ’s as opposed to federal courts. Third, the Fifth Circuit held that the SEC’s double layer of for-cause removal protection for administrative law judges was also unconstitutional.
Should the Supreme Court agree with the Fifth Circuit majority, its decision will very likely have a significant impact on the forum in which the SEC prosecutes enforcement actions for violations of federal securities laws by requiring that the SEC prosecute such actions in federal court, where statistics appearing in the media suggest that respondents stand a greater chance of litigation success. The case could also potentially disrupt how the SEC establishes rules and guidelines in other areas. Should the Supreme Court find that Congress is violating the Constitution by delegating overly broad authority to the SEC (and other agencies), it could restrict to a degree the ability of some SEC personnel seeking to promulgate detailed sets of rules and guidelines, even including possibly ESG policies and regulation of cryptocurrencies.
There is also the possibility that the Supreme Court’s decision in Jarkesy will implicate not only the SEC but also other federal administrative agencies. An affirmance in Jarkesy could have broad implications and impact the behavior of other federal agencies, particularly those that use their own in-house administrative tribunals to conduct enforcement proceedings or seek to promulgate their own rules and guidelines on policy matters.
It will take some time until Jarkesy is ripe for argument and even longer before the Supreme Court issues a decision. However, even if the Supreme Court ultimately reverses the Fifth Circuit, the recent grant of certiorari alone is likely to increase current uncertainty in how the SEC, and possibly other agencies, should conduct enforcement proceedings and promulgate new rules during the interim period prior to a definitive decision from the Supreme Court. It may also have an effect on the security of administrative law judges in their current positions.
The SEC Administrative Process
Founded in 1934 to regulate securities markets, the SEC was granted authority to appoint administrative law judges to conduct hearings in accordance with the Administrative Procedures Act (APA) of 1946.
Under current practice, claims brought by the SEC can be assigned to be heard by administrative law judges employed by the SEC, who act as fact finders and arbiters of the law. Determinations made by an ALJ can be appealed by either party to the Commission – consisting of five SEC Commissioners appointed by the President of the United States (and confirmed by the Senate). A decision by the Commission can then be appealed by petition to the federal court of appeals, which has limited authority to review the Commission’s determination. The federal court can only reverse the Commission’s findings of fact where there is “substantial evidence,” supporting that outcome and the Commission’s determination of the securities laws may be entitled to deference.
Historically, the SEC’s use of, and the remedies it could seek with, administrative proceedings was limited. Prior to 1990, it generally was required to bring securities fraud claims and seek civil penalties in federal court. With the passage of the Securities Enforcement Remedies and Penny Stock Reform Act of 1990, Congress first authorized the SEC to seek civil monetary penalties in administrative proceedings, but only as to “regulated” entities, i.e., entities that were regulated by the SEC.
In 2010, following the financial crisis and recession, Congress passed the Dodd-Frank Act. The Dodd-Frank Act expanded the SEC’s ability to bring fraud claims before administrative judges by granting the SEC discretionary authority to bring certain regulatory actions before its ALJ’s even against entities and individuals that are not regulated by the SEC. Following that, there was a noticeable increase both in the volume and complexity of cases that the SEC chose to bring before its administrative law judges rather than in federal court.
SEC v. Jarkesy
George Jarkesy founded a pair of hedge funds that managed approximately $24 million in assets from 120 investors. In 2013, the SEC commenced a civil enforcement proceeding against Jarkesy for securities fraud before an in-house administrative tribunal. Because Jarkesy was a non-regulated individual under the Securities Act, the SEC could not have commenced a claim before an ALJ against him prior to the passage of the Dodd-Frank Act in 2010.
The SEC claimed that Jarkesy, along with his advisory firm Patriot28, LLC, made false representations to their investors, including falsely advising that a prominent accounting firm and investment bank served as the funds’ auditor and broker, respectively, and misrepresenting the funds’ investment strategies and overvaluing the funds’ holdings.
The ALJ conducting the hearing found that Jarkesy committed securities fraud and imposed monetary and other penalties on him. Jarkesy appealed to the Commission, which affirmed the ALJ’s findings of fraud and penalties imposed. Jarkesy then appealed, as was his right, to the Fifth Circuit Court of Appeals. In a decision issued in May 2022, the Fifth Circuit found the SEC’s use of ALJ’s for civil prosecution of non-regulated individuals to be unconstitutional for three separate reasons.
First, the appeals court held that the use of administrative tribunals for enforcement of common law claims relating to private, not public, claims violated the Seventh Amendment right to a jury trial. In reaching that conclusion, the court examined the historical and central significance of the constitutional jury-trial right, finding it to be “one of our most vital barriers to governmental arbitrariness.” The court’s decision quoted the founding fathers, including John Adams who wrote that the jury trial was “the heart and lungs of liberty,” and noted that the Constitution would not have been ratified absent inclusion of the jury-trial right and that the desire to retain that right “was a catalyst for declaring independence.”
The Fifth Circuit found that, based on existing Supreme Court jurisprudence, the jury right applied to enforcement actions brought pursuant to statutes seeking civil penalties, because enforcement actions seeking civil penalties were similar to traditional actions concerning debt, for which a civil penalty was a legal remedy available at common law that could only be enforced in a court of law. The Fifth Circuit ruled that Congress could authorize administrative agencies to conduct proceedings before an ALJ for “public rights” created by statute that did not exist at common law – which were never subject to the jury right – but it held that “fraud actions under the securities statutes echo actions that historically have been available, under the common law,” and, though the government may be the enforcer, they are private right claims redressing private harms, and therefore subject to the Seventh Amendment’s right to a jury trial. Thus, enforcing such claims in agency proceedings violated the Seventh Amendment’s guarantee to a jury trial.
Second, the Fifth Circuit found that Congress violated the constitutional non-delegation doctrine by improperly delegating to the SEC broad discretionary authority to choose which enforcement cases to bring before its own ALJ’s as administrative proceedings and which to prosecute in federal court, without providing an “intelligible principle” to guide the SEC in making those determinations. As part of the separation of powers, Article I of the Constitution provides that only Congress has the authority to legislate, and Congress does not have the right to delegate its legislative powers to administrative agencies, which are part of the executive branch. The separation of powers in the Constitution helps ensure accountability whereby the populace will know who to hold accountable for the laws that are enacted.
The Fifth Circuit cited Supreme Court precedent that “Congress may grant regulatory power to another entity only if it provides an ‘intelligible principle’ by which the recipient of the power can exercise it.” The court held that the determination of which civil enforcement proceedings may be brought before administrative tribunals and therefore ALJs was an action squarely within the ambit of Congress’ legislative powers, and it found that Congress had not enacted any “intelligible principle” that would provide guidance to the SEC in exercising the delegated discretionary power to make that determination. It is important to note that the requirement of an “intelligible principle” may be found by the Supreme Court to apply in some circumstances to rule making by federal agencies including the SEC.
Finally, the Fifth Circuit held that statutory provisions providing for a double layer of for-cause removal protection of the SEC’s administrative law judges violated the Take Care Clause of the Constitution, which, the Supreme Court has held, “guarantees the President a certain degree of control” over the appointment and, importantly, removal of executive officers. According to the Fifth Circuit, under Supreme Court precedent, Congress could not grant executive officers “two layers of for-cause protection” from removal, as such a practice may impede the President’s constitutional ability to oversee the removal process.
Possible Risks and Implications for the SEC
More than a full year has passed since the Fifth Circuit issued its historic decision in Jarkesy. The case is currently scheduled for the upcoming 2023-2024 Supreme Court Term, and the current briefing schedule extends through October 2023. Assuming the case is argued in the next term (the parties have already been granted an extension for submitting briefs), a decision may not come down until June or July of 2024, or possibly later.
This extended interim period following the grant of certiorari creates uncertainty for the SEC. While the Fifth Circuit has deemed the SEC’s administrative enforcement proceedings unconstitutional, that decision is not binding in other federal jurisdictions, and the SEC could theoretically continue to exercise its discretion and try securities fraud cases and seek civil penalties through its administrative tribunals in cases outside of the Fifth Circuit’s jurisdiction. Doing so, however, before the Supreme Court rules in Jarkesy, comes with significant risk. In the event that the Supreme Court affirms and finds the SEC’s administrative procedures to be unconstitutional, then any such proceedings in the period prior to that ruling that resulted in a finding of wrongful conduct (as most often they do), could be deemed unconstitutional and overturned.
Implications for the SEC
Requiring the SEC to prosecute civil enforcement actions in federal court could have broad implications for the SEC. According to statistics published by the Wall Street Journal, the federal courts may be a forum where success for respondents is more likely, as the SEC’s success rate in federal court is reported to be materially lower than its success rate before its in-house administrative tribunals. Thus, forcing the SEC to go to federal court could provide a benefit for individuals or entities accused of securities fraud, as they may stand a better chance of defending those fraud claims. Some would argue that would increase fairness because of the process used. The SEC could also opt to prosecute fewer fraud cases, which may result in adverse consequences to consumers, who are the ultimate victims of securities fraud, by emboldening individuals who might commit fraud.
There are additional risks for the SEC if the Fifth Circuit’s majority opinion is upheld by the Supreme Court, particularly concerning the SEC’s promulgation of broad rules and regulations in areas arguably beyond what falls within the ambit of statutory authority because of the non-delegation doctrine.
The SEC will have to carefully consider if and how it will adopt new rules or provide guidance in other areas that only tangentially relate to securities law. There will be a looming question as to whether any new regulations by federal agencies including the SEC violate the non-delegation doctrine including by failing to provide an “intelligible principle” to limit such rulemaking.
There is, as an important example, the possibility of potential implications concerning environmental, social, and governance (ESG) rules that the SEC may seek to implement. In March and May of 2022, the SEC circulated for comment proposed detailed climate and ESG reporting and compliance rules that were quite demanding in many respects. The proposed rules would require, among other things, ESG and climate-related disclosures by regulated entities, including the disclosure of ESG strategies, greenhouse gas emissions, information on specific ESG impacts funds seek to achieve, as well as establishing reporting requirements relating to ESG policies. The proposed disclosure requirements, which resulted in thousands of comments and have yet to be implemented, followed on the heels of the SEC’s creation of a Climate and ESG Task Force back in 2021, tasked with finding ways to “proactively identify ESG-related misconduct.” The SEC has since brought on enforcement actions in connection with ESG related misconduct. Assuming the Supreme Court affirms Jarkesy, it is possible that some of the newer ESG related rules exceed the SEC’s existing authority.
Some of the comments submitted on the SEC’s proposed ESG rules raised the concern of whether the SEC was exceeding its delegated authority. That position would likely become more widespread should the Supreme Court affirm in Jarkesy on unconstitutional delegation grounds. The SEC would have to carefully consider whether it has the constitutional authority to issue broad ESG rules and whether, even if it were granted such authority by Congress with “intelligible principles” given by Congress.
There are also other areas in which the SEC may seek to promulgate new rules. According to former SEC Commissioners, existing securities laws are insufficient for regulating cryptocurrencies and digital asset markets, and there is debate on whether digital assets are considered securities under current law. Should the SEC determine that new rules are needed to regulate digital assets, would it be confident it could create those rules on its own without waiting for Congress to act?
These examples highlight the potential risks and uncertainty for the SEC with enacting rules and polices in new areas, absent “intelligible principles” emanating Congress until the Supreme Court rules in Jarkesy.
Beyond the SEC
Beyond the potential implications for the SEC, the possibility of an affirmance in Jarkesy raises the possibility of broader implications for other federal agencies and their use of administrative proceedings for civil enforcement.
There are more than two dozen federal agencies that make use of their own administrative tribunals for various purposes, including civil enforcement proceedings. Some of them employ a considerable number of ALJ’s. Should the Supreme Court strike down the ability of federal agencies to employ administrative tribunals for enforcement actions or other fraud actions not involving a “public right,” those agencies will have to adjust to that ruling in some of the same ways as described above for the SEC.
The Supreme Court’s grant of Certiorari in Jarkesy has created significant uncertainty for the SEC and some other federal agencies, and they will have to navigate cautiously until the Supreme Court decides the constitutional issues raised in Jarkesy. Even should the Supreme Court ultimately reverse the Fifth Circuit, the interim period will have been fraught with uncertainty. An affirmance by the Supreme Court will have broad implications for the federal administrative agency system.
 Technically called the Dodd-Frank Wall Street Reform and Consumer Protection Act, it amended over a dozen federal Acts, including the Securities Exchange Act of 1934. See Pub. L. No. 111-203, 124 Stat. 1376 (2010).
See SEC’s Petition for Writ of Certiorari, at 3, SEC. v. Jarkesy (No. 22-859).
Id. at 3–4. Jarkesy initially filed a collateral action before the U.S. District Court for the District of Columbia, arguing that the administrative proceeding was unconstitutional. The district court, in a decision that was affirmed on appeal, held that it lacked jurisdiction because Jarkesy first had to exhaust the administrative process before he could raise any such arguments to the Court of Appeals. SeeJarkesy v. SEC, 48 F.Supp 3d 32, 40 (D.D.C. 2014), aff’d, 803 F.3d 9, 12 (D.C. Cir. 2015).
 The Seventh Amendment provides that “in Suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise reexamined in any Court of the United States, than according to the rules of the common law.” U.S. Const., Amend. VII.
Id. at 455. The fact that the securities statutes were enacted to protect the public did not convert a claim for civil penalties based on securities fraud, which existed at common as actions in debt, into a public right. And requiring such enforcement actions to be brought before Article III courts of law would not dismantle the statutory scheme, as such actions have historically been brought in federal courts and, in fact, under the current statutory scheme, the SEC was authorized to bring as many such proceedings as it chose in federal court. Id. at 455–56.
 Id. at 461 (citing Mistretta v. United States, 488 U.S. 361 (1989)). The court found that Congress had, in fact, not provided the SEC with any guidance at all on how or when to exercise such discretion. That, according to the Fifth Circuit, is what differentiated this case from any other case considered by the Supreme Court in the past eighty years, where the Supreme Court has not found that Congress failed to provide the requisite intelligible principle. The last time that the Supreme Court considered a matter in which Congress failed to provide any guidance at all, it found unconstitutional the delegation of the legislative powers at issue. See id. at 462 (citing Panama Refining Co. v. Ryan, 293 U.S. 388 (1935)).
 The Take Care Clause provides that “[the President] shall take Care that the Laws be faithfully executed.” U.S. Const., Art. II, § 3.
 Given the authority SEC ALJ’s possess over administrative proceedings, the Supreme Court had previously held that they were considered “inferior officers.” See id. at 464 (citing Lucia v. SEC, 138 S. Ct. 2044 (2018)).
Id. at 463–464. Unlike with the first two grounds, the Fifth Circuit expressly did not hold whether the third ground alone was sufficient to reverse the SEC’s findings against Jarkesy.
 There is also the possibility that the Supreme Court will affirm the Fifth Circuit’s finding of unconstitutionality on only one or two of the grounds on which the Fifth Circuit based its holding. For example, the Supreme Court could determine that the use of the SEC’s administrative tribunals for civil enforcement proceedings violates the Seventh Amendment right to a jury trial, but that Congress did not unconstitutionally delegate discretionary authority to the SEC. Under that scenario, there would not be any additional risk (above what currently exists) to the SEC in promulgating new rules and regulations.