Supreme Court Curtails Use of Administrative Courts in SEC Enforcement Proceedings: What it Means for Other Agencies and What Happens Next

The U.S. Supreme Court has ruled that defendants in securities fraud cases brought by the SEC are entitled by the Seventh Amendment to have the SEC’s claims for civil money penalties decided by a jury and not in an administrative proceeding. The opinion is narrower than it might have been as the Court did not rule on two other questions the case presented. It also is unclear how broadly the rule it announced will be applied and what impact it will have on dozens of other federal agencies that can seek civil penalties for violations of law.

At a Glance: Key Background on the Case

The case—SEC v. Jarkesy—originated with an administrative proceeding brought by the SEC against a hedge fund founder and the fund’s investment adviser that the agency claimed made material misleading statements to investors to collect larger management fees.

An administrative law judge (ALJ) barred the defendants from the securities industry, fined them $300,000, and required them to disgorge more than $600,000 in earnings. The SEC brought the case as an administrative proceeding through authority granted to it through the Dodd-Frank Act.

The U.S. Court of Appeals for the 5^th Circuit vacated the ALJ’s final order, holding that the SEC’s decision to adjudicate the matter in an administrative forum violated the defendants’ Seventh Amendment right to a jury trial. The appeals court also ruled that SEC ALJs are unconstitutionally protected from removal and that under the nondelegation doctrine, Congress lacks the power to give the SEC the ability to decide whether to bring cases in an administrative proceeding or by filing a case in federal court.

What the Supreme Court Decided

The majority opinion, authored by Chief Justice Roberts and joined by five other justices, held that the SEC’s claims fell under the Seventh Amendment’s right to a jury trial, meaning the SEC must seek civil money penalties in an Article III court instead of through an administrative proceeding.

In reaching this conclusion, the majority focused on the nature of the SEC’s claims and whether they are “made of the stuff of the traditional actions at common law tried by the courts at Westminster in 1789,” and concluded that “[t]he SEC’s antifraud provisions replicate common law fraud, and it is well established that common law claims must be heard by a jury.”

The opinion also explained that the public rights doctrine did not apply, and also made clear that the Court was not overruling the Atlas Roofing decision, which permits OSHA to seek civil money penalties in administrative proceedings. The majority explained that, in Atlas Roofing, the enabling statute created a new “public right” and authorized the agency to bring a type of claim that did not exist at common law and to enforce those claims in administrative proceedings.

As Justice Sotomayor’s dissent argued, this leaves open the question of whether and how the two decisions can be reconciled and further muddies the waters on the scope and application of the public rights doctrine.

What’s Next: Three Things That Are Likely to Change Due to the Decision

1. Expect litigation challenging the practices of at least two dozen federal agencies that can seek monetary penalties via administrative proceedings.

• The Court did not limit the application of its ruling to the SEC’s civil penalty statute.
• The CFPB, Treasury Department, HUD, CFTC, EPA, FCC and the DOJ are among the agencies that seek monetary penalties in administrative proceedings, as Justice Sotomayor’s dissent notes.
• It will be interesting to see how lower courts handle these cases and what, if any, distinctions emerge that might permit certain types of claims to proceed in the administrative courts.

2. Given that the case did not overrule Atlas Roofing and eliminate the public rights doctrine, agencies will have to litigate whether a remedy is more akin to a common law fraud claim that falls under the Seventh Amendment’s right to a jury trial, or more like OSHA violations that enforce a “public right” that did not exist under common law.

3. Agencies whose statutes do not permit them to bring cases in Article III courts, such as FERC, will need a statutory fix. Other agencies could try to sidestep the ruling by changing their rules to allow defendants to move proceedings to an Article III court.

• Expect agencies to seek additional funding or shift resources to bring on trial attorneys to bring cases in federal district courts.
• Agencies also may try to adapt to this ruling on their own without relying on Congress.

Left Unchanged: Three Things the Ruling Does Not Impact

1. The Court’s ruling did not address the administrative law judge’s order banning Jarkesy from the securities industry. As a result, it seems that proceedings seeking to bar individuals from a regulated industry can likely proceed in administrative courts.

• However, these bans can have collateral consequences that can result in limitations on being able to earn a living in a tangential field without the benefit a jury trial, which may be ripe for additional challenges. For instance, an SEC order banning a person from associating with broker-dealers and investment advisers can often adversely impact such a person’s ability to subsequently associate with a non-securities related financial services institution if licensing requirements require disclosures of any adverse regulatory actions.

2. The ruling will not directly affect proceedings in state-level administrative tribunals.

3. The ruling does not impact an agency’s ability to resolve claims via consent orders or other settlements.

To Be Determined: Questions the Supreme Court Decision Does Not Directly Resolve

1. It’s unclear what impact, if any, the decision will have on proceedings brought by self-regulatory organizations (SROs), such as FINRA, which can impose monetary penalties on securities industry professionals through its own administrative forums.

• Although FINRA and other SROs are not governmental agencies per se, they are subject to SEC oversight and their activities are governed by federal statute.
• Persons subject to adverse FINRA findings must first generally seek relief from the SEC before turning to the courts.

2. It will be important to watch how this ruling impacts federal banking regulators—the FDIC, OCC and Federal Reserve Bank.

• These agencies do not have the ability to bring cases in federal court and can only bring enforcement actions through consent order in certain circumstances.
• For example, the Fed can bring can an enforcement action if a bank has engaged in an unsafe or unsound practice or violated the law. The FDIC and OCC can pursue enforcement actions for violations of laws, rules or regulations; unsafe or unsound banking practices; breaches of fiduciary duty and violations of final orders, conditions imposed in writing or written agreements.
• Which of these types of actions fall within Jarkesy as opposed to Atlas Roofing surely will be hotly litigated.

3. The Court’s ruling did not address two of the three questions presented in the case.

• One of these is whether Congress can provide two levels of removal protection for administrative law judges. That issue is pending in several cases working their way through the lower courts. So, while the Fifth Circuit’s ruling that invalidated the double removal protections stands for now, this issue will very likely be before the Court for decision in the next few years.
• The other question the Court did not address asks whether Congress violated the nondelegation doctrine by providing the SEC with no “intelligible principle” for deciding whether to pursue a civil-penalty action before an administrative law judge or Article III court. This issue is not on its way back to the Court, but the Fifth Circuit’s ruling that Congress violated the doctrine will very likely be tested in other cases.

4. It remains to be seen how the SEC will handle the Supreme Court’s decision from a strategic perspective.

• Will it bring cases for injunctive relief in front of administrative law judges and then proceed against the same defendant for civil penalties in District Court, forcing defendants to battle the SEC on two fronts?
• This will likely result in protracted and expensive litigation, but may be worth it to the SEC in cases where speedy injunctive relief is necessary to stop alleged harm against investors.

5. It’s unclear if this ruling will present an opportunity for the Court to revisit binding arbitration provisions.

• Some scholars have perceived tension between the Seventh Amendment’s guarantee of the right to a jury trial and the ubiquity of arbitration agreements, particularly in employment law and consumer financial services.
• Now that Congress can no longer direct common law causes of action away from Article III courts, private parties might face challenges to their ability to remove common law causes of action from Article III courts to binding arbitration, to the extent that a party can show that boilerplate language in an agreement is not a “knowing and voluntary” waiver of their right to a jury trial.

If you have any questions, reach out to our authors ( Leslie Meredith, Amanda Lawrence, Ignacio Sandoval and Amy Walsh) or another member of the Orrick team.