U.S. Supreme Court Significantly Curtails SEC Enforcement Forum Discretion

On June 27, 2024, the United States Supreme Court issued a much-anticipated decision in Securities and Exchange Commission v. Jarkesy,¹ holding that parties subject to an enforcement action brought by the U.S. Securities and Exchange Commission (“SEC” or “Commission”) for violations of anti-fraud provisions seeking civil money penalties have a Seventh Amendment–guaranteed right to a trial by jury. As a result, the SEC must bring such actions in federal court, rather than adjudicating matters before the Commission’s in-house administrative law judges (“ALJs”). Chief Justice Roberts, joined by Justices Thomas, Alito, Gorsuch, Kavanaugh, and Barrett, authored an opinion affirming the decision of the U.S. Court of Appeals for the Fifth Circuit. While this represents another significant loss for the Commission, its immediate practical impact — at least for the SEC — will likely be limited.

Background

The SEC typically has the option to bring an enforcement action in federal court, or to adjudicate the matter in-house, where the Commission acts as fact finder or delegates the decision to an ALJ. Prior to 2010, the SEC could only obtain civil monetary penalties against unregistered parties in federal court. However, with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the SEC was given the power to impose civil penalties against such parties in administrative cease-and-desist proceedings.

In March 2013, the SEC initiated an enforcement action seeking, among other sanctions and relief, civil money penalties against investment advisor George Jarkesy and his firm, Patriot28, LLC, for alleged violations of the antifraud provisions of the federal securities laws. The Commission opted to proceed with an in-house administrative proceeding. In 2014, the presiding ALJ issued an initial decision. The respondents appealed the decision and the Commission released its opinion in 2020. In its opinion, the Commission found that Jarkesy and Patriot28 had committed securities violations, and the SEC imposed a civil money penalty of $300,000. Jarkesy and Patriot28 filed a petition for review before the Fifth Circuit, arguing that: 1) the SEC’s penalties violated the Seventh Amendment; 2) Congress violated the nondelegation doctrine by giving the SEC the choice to decide whether to litigate an enforcement action or proceed by administrative adjudication; and 3) the robust for-cause provisions for the SEC’s ALJs violated the separation of powers. The Fifth Circuit agreed with Jarkesy and Patriot28 on all three of these arguments. The federal government petitioned for certiorari on all three issues, which the Court granted in full. In deciding the case, however, the Court reached only the Seventh Amendment question.

Analysis of the Opinion

The Court began its opinion by concluding that the civil money penalties imposed on Jarkesy were intended to “punish and deter,” making them a remedy at common law that can only be enforced in a court of law. The Seventh Amendment guarantees the right of trial by jury in “[s]uits at common law,” which, as the Court observed, embraces statutory claims that are legal in nature, where the remedy is the sort that is traditionally obtained in a court of law. Whether a remedy is traditionally obtained in a court of law turns on whether it is designed to punish or deter the wrongdoer, or, alternatively to “restore the status quo.” Because the SEC is not obligated to use civil money penalties to compensate victims of purported fraud — i.e., the penalties are not intended to be restorative — the Court concluded that the penalties were punitive, which meant the underlying claims were legal in nature and could only be pursued in court.

Second, the Court determined that the SEC’s action implicated the Seventh Amendment because the SEC’s antifraud provisions replicate common law fraud. The Court noted that Congress drafted the federal securities laws with common law terms of art, such as “fraud,” in mind, so courts will often consider common law principles when interpreting federal securities laws. Given this overlap, it was not difficult for the Court to conclude that the fraud causes of action in the securities laws have a “close relationship” with common law fraud, thereby confirming that the SEC’s securities fraud claims are “legal in nature,” thus implicating the Seventh Amendment.

Third, the Court held that the “public rights” exception to the Seventh Amendment does not apply to SEC claims seeking civil penalties. Under the Seventh Amendment, a jury trial is required unless the “public rights” exception applies, where Congress may assign the matter for decision to an agency without a jury. The Court held this exception did not apply to the SEC’s securities fraud claims against Jarkesy and Patriot28, as the exception typically applies to, among other things, the granting of public benefits, the collection of revenue, immigration law, and relations with Indian tribes — matters with no private rights overlay.

The SEC argued that the public rights exception applied because Congress had created new statutory obligations, imposed civil penalties for their violation, and committed to the SEC the function of deciding whether a violation had occurred. But the Court rejected the SEC’s position, explaining that Congress had no power to “siphon” the action away from a federal court. The SEC also argued that the exception should apply because the Government was the party prosecuting the action. The Court clarified that the presence of the United States as a party was not itself sufficient to trigger the public rights exception — and that what matters is the substance of the suit and not where it is brought or who brought it.

Key Takeaways

Civil money penalties are one of the SEC’s sharpest enforcement tools, and the agency wields this tool with significant discretion. Penalties can reach up to $1.15 million per violation, after adjusting for inflation, and may be issued even where no investor has actually suffered any financial loss. Moreover, the SEC has a number of ways to “count” violations, based on the “tier” of the violation, as well as other factors. Jarkesy’s bottom line is clear as far as the SEC is concerned: if the agency intends to pursue civil penalties on a claim that resembles common law fraud, it will be required to seek those penalties in federal court.

While Jarkesy further cabins the SEC’s ability to adjudicate claims using ALJs, it is unlikely that the decision will have a significant practical effect on the SEC’s docket. For a number of years, the SEC has brought the vast majority of its contested enforcement actions in federal court (the exceptions generally involving matters in which the claim and/or relief sought is not readily available in federal court proceedings).

Jarkesy is limited on its face to SEC fraud cases seeking civil penalties. It remains to be seen whether the decision will hamstring other SEC enforcement efforts. The Supreme Court’s decision does not address the Commission’s use of administrative hearings on matters that do not involve fraud, nor does it address the use of administrative hearings to impose sanctions other than monetary ones, including professional bars or suspensions.

 

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^[1] Sec. & Exch. Comm’n v. Jarkesy, No. 22-859, 2024 WL 3187811 (June 27, 2024).

 

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