SEC v. Jarkesy: Supreme Court eliminates a significant agency enforcement tool – broad implications, key takeaways

On June 27, 2024, the US Supreme Court ruled that the Securities and Exchange Commission (SEC) cannot use its administrative courts, instead of Article III federal district courts, to decide securities fraud claims seeking civil penalties. Securities & Exch. Comm’n v. Jarkesy, No. 22-859 (2024) (“Jarkesy”). The Court held that the Seventh Amendment “entitles the defendant to a jury trial when the SEC seeks civil penalties against him for securities fraud.” Slip Op. at 6.

In reaching its decision, the Supreme Court first concluded that the SEC’s antifraud provisions “replicate common law fraud,” thereby requiring that a jury hear such claims. Second, the Court concluded that the public rights exception to a defendant’s jury trial right did not apply to SEC antifraud claims, because such claims did not fall within “any of the distinctive areas involving governmental prerogatives where the Supreme Court has previously concluded that a matter may be resolved outside of an Article III Court, without a jury.” Slip Op. at 7. The Court declined to rule on two other constitutional challenges to the SEC’s administrative process presented in the Jarkesy case.

As discussed below, Jarksey eliminates a significant SEC enforcement tool, and also has broader implications for both the SEC and other administrative agencies who use administrative courts as part of their enforcement arsenals.

Background

Prior to 2010, under relevant securities laws, the SEC was authorized to seek civil penalties for securities fraud only in Article III courts, where defendants have the right to a jury trial. In 2010, Congress passed the Dodd-Frank Act, which expanded the SEC’s authority, and allowed it to seek civil penalties for securities fraud in the agency’s administrative courts. If the SEC chose to sue a defendant for securities fraud and seek penalties in an administrative proceeding, the defendant was no longer entitled to a jury trial.[1]

In 2013, Jarkesy and the investment adviser, Patriot28 were charged by the SEC with committing securities fraud. The SEC brought the enforcement action in its administrative court. After years of litigation, the SEC found Jarkesy and Patriot28 liable for securities fraud, and imposed a $300,000 civil penalty. Jarkesy and Patriot 28 sought review of the SEC’s decision in the Fifth Circuit.

As discussed in our prior alert, the Fifth Circuit vacated the SEC’s decision and remanded for further proceedings consistent with its opinion. Jarkesy v. Sec. & Exch. Comm’n, 34 F.4th 446 (5th Cir. 2022). The Fifth Circuit held that the SEC’s use of an administrative law judge (ALJ) to adjudicate the claims was improper because:

1. The administrative proceeding deprived the petitioners of their Seventh Amendment right to a jury trial
2. Congress had unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise the delegated power, and
3. The statutory removal restrictions on SEC ALJs violate Article II of the Constitution.

The Supreme Court granted the SEC’s petition for certiorari on all three issues addressed by the Fifth Circuit, although the Court ultimately decided only the first issue.

The Supreme Court’s decision

In reaching its decision that the SEC’s use of its administrative court to adjudicate the case against Jarkesy and Patriot28 violated their Seventh Amendment rights to a jury trial, the Court engaged in a two-stage analysis:

1. Whether the Seventh Amendment’s right to trial by jury was implicated, and if so,
2. Whether Congress was permitted to assign the claims to agency adjudication without a jury trial under the public rights exception.

The Court’s analysis of the right to a jury trial

In evaluating the first question, the Court explained that the Seventh Amendment extends to any statutory claim that is “legal in nature,” (rather than sounding in equity), even where those statutory claims are brought by the government. The Court emphasized that to determine whether a suit is legal in nature, courts should consider the cause of action and the remedy it provides – with the latter being the “more important” consideration. The Court readily concluded that the SEC’s cause of action was legal in nature because its antifraud provisions replicated common law fraud.

In evaluating the remedy sought, the Court held that the statutory factors underpinning the civil penalty remedy – factors that included “culpability, deterrence, and recidivism” – aimed at punishing or deterring defendants, rather than compensating victims. For those reasons, the SEC’s civil penalty claims were legal in nature, and the defendants had a constitutional right to have the claims against them tried by a jury under the Seventh Amendment.

The Court’s analysis of the “public rights” exception

In the second part of its analysis, the Court turned to whether the SEC’s securities fraud civil penalty claims could be decided by an ALJ under the narrow “public rights” exception, by which Congress may assign certain matters to an agency, rather than a jury. The Court stressed that generally matters concerning private rights may not be removed from Article III courts, and here, the SEC’s civil penalty claims implicated the defendants’ private rights. The Court reiterated that “Congress cannot conjure away the Seventh Amendment by mandating that traditional legal claims be taken to an administrative tribunal.” Slip Op. at 21.

The Court distinguished prior precedent applying the “public rights” exception, because those cases applied the exception only where the claim related to matters that were historically determined by the executive and legislative branches, including the powers to:

1. Collect revenue
2. Regulate immigration
3. Impose tariffs
4. Conduct relations with Native American tribes
5. Administer public lands, and
6. Grant public benefits such as payments to veterans, pensions and patent rights. See Slip Op. at 13-17.

In addition, the Court held that the “public rights” exception could apply where the claims assigned to the administrative forum involved “‘a new cause of action, and remedies, therefor, unknown to the common law.’” Slip Op. at 24 (citation omitted.) The Court rejected the SEC’s position – ardently defended in a dissent by Justice Sonia Sotomayor – that public rights are necessarily involved where a government agency brings suit under a statutory grant of authority. The Court held that where a statute borrows from pre-existing common law claims, as the SEC’s anti-fraud provisions did in this case, the public rights exception does not apply: “what matters is the substance of the suit, not where it is brought, who brings it, or how it is labeled.” Slip Op. at 21.

Looking ahead

While Jarkesy applies directly to the SEC, its evaluation of when an agency claim implicates the right to a jury trial, and its interpretation of the “public rights” exception, extends far beyond that agency. The decision opens up a wide range of potential constitutional challenges to agency administrative actions, including:

• Whether an agency’s particular claim for civil penalties in an administrative forum is legal in nature, and therefore implicates the defendant’s right to a jury trial
• Whether a claim for civil penalties that implicates the right to a jury trial nonetheless falls within the “public rights” exception as either a claim historically decided by the executive or legislative branches, or as a claim involving a new cause of action and remedies that were unknown to the common law
• Whether an agency’s claim for fraud, brought administratively, implicates the right to a jury trial, regardless of whether penalties are sought, and
• Whether other types of claims brought within an administrative forum implicate the right to a jury trial.[2]

Separately, the additional bases used by the Fifth Circuit to determine that the SEC’s administrative process was constitutionally flawed still hold in that Circuit, and provide additional grounds for challenges to administrative proceedings based on:

• Violations of the non-delegation doctrine, and
• Violations of the separation of powers due to alleged unconstitutional ALJ removal provisions.

With the Court’s even more momentous Loper Bright ruling – unwinding Chevron deference – announced on June 28, 2024, challenges to the SEC’s interpretation of statutory provisions for recent rulemaking, such as the climate disclosure rule, will face even more intense litigation challenges.

Between Loper Bright and Jarkesy, the SEC and other administrative agencies have suffered a one-two punch: administrative regulatory interpretations will no longer receive deference, and the ability to enforce those regulations administratively is likely to face serious constitutional challenges. Moreover, under the Court’s earlier decision in Axon Enter., Inc. v. Fed. Trade Comm'n and Securities and Exchange Commission v. Cochran,[3] discussed here, these constitutional challenges will likely play out in district court.

While the SEC has, for the last few years, initiated most contested cases in federal court, open questions regarding the legitimacy of the administrative process more broadly will likely add complexity to agency enforcement actions instituted as administrative proceedings.

Please contact any of the authors, or your usual DLA Piper contact to learn more about these issues and DLA Piper’s Appellate and Administrative Law practices.


^{[1] While the Court’s opinion focused on the lack of a jury trial, both the majority and Justice Neil Gorsuch in his concurring opinion noted that administrative forums lack other procedural protections, including protections relating to who presides over and makes legal determinations, what discovery is available, what evidentiary rules apply, and who determines the facts. In addition, judicial review of agency administrative decisions is deferential. See Slip op. at 3 and Concurring op. at 3-4 and n. 1 (Gorsuch J.)
[2] Whether litigants will seek to challenge the validity of administrative proceedings based on other procedural differences between Article III courts and administrative proceedings is an issue for the future. Jarkesy did not address those questions.
[3] 598 U.S. 175 (2023).}