Supreme Court rules SEC’s in-house enforcement unconstitutional

In a 6-3 decision, the Supreme Court ruled June 27 that the Securities and Exchange Commission’s use of in-house judges to adjudicate enforcement cases violates an American’s constitutional right to a jury trial.

The decision invalidates the SEC's use of administrative law judges, or ALJs, which are appointed by the president and handle the agency’s enforcement cases internally.

“A defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator,” Chief Justice John Roberts wrote in the majority opinion.

The Supreme Court first agreed to hear the case, SEC vs. Jarkesy, in July following a May 2022 petition from the SEC to do so. The 5th U.S. Circuit Court of Appeals in New Orleans had also ruled against the regulator, finding that the SEC’s use of ALJs was unconstitutional.

“This case poses a straightforward question: whether the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties against him for securities fraud ... It does,” Roberts wrote in the opinion.

The case stems from an enforcement action the SEC filed over a decade ago. In 2011, the agency began investigating George R. Jarkesy Jr. after he selected Patriot28 as the investment adviser for two hedge funds he established. Then in 2013, the agency instituted an administrative enforcement action against Jarkesy and Patriot28 regarding their alleged mismanagement before an ALJ.

Jarkesy went on to sue the SEC, arguing the regulator’s structure and enforcement powers violated the Constitution, according to a client alert from law firm Troutman Pepper Hamilton Sanders.

The ALJ function was created by the Administrative Procedure Act in 1946 to ensure fairness in administrative proceedings before federal government agencies, according to U.S. Office of Personnel Management's website.

The Supreme Court’s conservative majority appeared skeptical of the SEC’s defense during oral arguments on Nov. 29. However, the dissenting justices said invalidating the SEC’s existing enforcement authority could have wide-reaching consequences.

Justice Sonia Sotomayor wrote in the dissenting opinion that “dozens of agencies could be stripped of their power to enforce laws enacted by Congress.”

“This doesn't end administrative proceedings for other agencies," said Jay. A Dubow, a partner at Troutman Pepper Hamilton Sanders and co-lead of the firm’s securities investigations and enforcement practice group. "But I think in certain circumstances, depending on the agency and depending on what it is they're seeking in terms of relief, it's going to open the door for challenges to those proceedings."

Due to a number of challenges in recent years, the SEC has cut back on its use of ALJs, according to Dubow, so the agency will likely not be too impacted by the decision.

“The (majority) opinion, also, as I read it, focuses on fraud; it focuses on civil money penalties,” Dubow said, meaning that the SEC may still be able to bring administrative proceedings in certain cases.

In her dissent, Sotomayor called the majority opinion’s focus on fraud and civil money penalties an attempt to “disguise” the impact of its decision.

“That incredible assertion should fool no one. Today’s decision is a massive sea change,” Sotomayor added. “Litigants seeking further dismantling of the ‘administrative state’ have reason to rejoice in their win today, but those of us who cherish the rule of law have nothing to celebrate," she wrote.

Gurbir Grewal, director of the SEC's Division of Enforcement, said in a June 27 statement that "the SEC will continue to protect investors and enforce the federal securities laws, including by filing actions in federal court. Indeed, during the last several years, the SEC has successfully enforced the federal securities laws in federal court, obtaining favorable jury verdicts and dispositive motion rulings in highly contested matters with industry-wide implications."

“We are reviewing today’s ruling and its impact on the SEC’s administrative proceedings, and would like to thank all of the dedicated public servants who represented the government in this matter," Grewal added.