Lucas Bowerman

Associate Editor

Loyola University Chicago School of Law, JD 2024

 

On May 18, 2022, the United States Court of Appeals for the Fifth Circuit issued a novel and divisive decision that greatly restricts the administrative enforcement powers of the SEC and its use of Administrative Law Judges (ALJs) in Jarksey v. SEC. Although much deliberation has been had over the implications and immediate impact of this ruling, the takeaway is that the Securities and Exchange Commission (SEC) may be facing significant challenges to its internal enforcement procedures in the near future.

The Jarksey decision

The decision arose from allegations brought against hedge fund manager George Jarksey for misrepresentations and inflationary valuations to investors. After an SEC administrative judge and an internal appeal found Jarksey liable, he brought forth several arguments on the constitutionality of SEC administrative adjudication. The Fifth Circuit made three significant holdings in its decision, each addressed in turn:

(1) The SEC’s in-house adjudication of Petitioners’ case violated their Seventh Amendment right to a jury trial.

Drawing upon a wide history of the common law and the SEC’s enforcement proceedings, the court initially determined that action in this case involved a claim for fraud. Neither the common law nor Supreme Court precedent dictates that fraud can be decided through agency adjudication, nor did the SEC’s presence in the action necessitate such a proceeding that lacked an important constitutional right.

The court also focused on the “public rights” doctrine, which “arise[s] when Congress passes a statute under its constitutional authority that creates a right so closely integrated with a comprehensive regulatory scheme that the right is appropriate for agency resolution.” However, the SEC’s enforcement action was more “akin to traditional actions at law to which the jury-trail right attaches.” Because Congress cannot circumvent Seventh Amendment rights by assigning traditional legal claims to an administrative tribunal, traditional understanding and precedent dictated that such claims should be decided by a jury.

(2) Congress unconstitutionally delegated legislative power to the SEC by failing to provide an intelligible principle by which the SEC would exercise the delegated power, in violation of Article I’s vesting of “all” legislative power in Congress.

Precedent dictates that Congress can delegate agency power under Article I only if it applies an “intelligible principle” or guiding condition, commonly referred to as the non-delegation doctrine, a previously utilized administrative law principle that prohibits Congress from delegating legislative powers to administrative agencies. Congress failed in its designation of quasi-judicial power to articulate when the SEC should choose between administrative law judges or District Courts.  

(3) Statutory removal restrictions on SEC ALJs violate the Take Care Clause of Article II.

Arguably the strongest section of the opinion, and left open by previous Supreme Court case law, the court held that SEC ALJs are inferior officers, insulated from the President through two layers of for-cause protection that prevent the President from having adequate control through removal to “take Care that the Laws be faithfully executed.”

Implications for the SEC; future Supreme Court cases

The ability of the SEC to impose civil money penalties stems from the passage of the Dodd-Frank Act in 2010, which attempted to resolve many of the loopholes and exploitations that lead to the financial crisis in 2008. The Dodd-Frank Act gave the SEC, in addition to providing a host of mandatory rulemaking provisions, the ability to assess civil monetary penalties against unregistered entities.

While this case signals that some Federal Circuits are keen on reviving the non-delegation doctrine and removing the ability of administrative agencies to handle cases internally, the holding is likely to be limited, given that the SEC has greatly restricted its administrative proceedings following the Supreme Court’s changes to ALJ appointments in Lucia v. SEC. The SEC is not the only administrative agency that has the ability to impose steep civil penalties.

Ultimately, the SEC faces a tough decision in choosing to seek writ of certiorari or en banc review before the Fifth Circuit. While Justice Roberts has previously spoken in favor of SEC adjudications (like in Free Enterprise Fund), the Court is increasingly hostile of decisions from the Warren court and those surrounding the administrative state. The Jarkesy decision created a circuit split with the Ninth Circuit in Decker Coal v. Pehringer, which rejected a challenge to ALJ removal protections for the Department of Labor – giving the Court a promising reason to resolve the conflict. In addition, the Court has granted certiorari to two similar cases, SEC v. Corchran and Axon Enterprises, Inc. v. FTC, both of which seek to challenge the structure of administrative proceedings prior to forcing a defendant to submit to jurisdiction.

This decision was wrongly decided. Jarksey unduly inhibits the SEC in adjudicating its own regulations, an especially important consideration to consider with the SEC seeing an increase in enforcement actions in 2021. Furthermore, here is arguably no historical justification for the non-delegation doctrine. A sounder interpretation of the public rights doctrine lies with the dissent, as “the Government sue[d] in its sovereign capacity to enforce public rights created by statutes within the power of Congress to enact.” For an approach centered on originalism, the majority failed to take into account a proper historical inquiry of whether a claim for fraud is considered a public right. This decision will only lead to the SEC delaying bringing fraud claims in administrative courts until the case is resolved, meaning years of delayed decisions and potential lack of enforcement of SEC violations.

In conclusion, the realm of administrative adjudication, for better or for worse, is set to change in the Court’s next term. Many defendants may now feel empowered to raise these constitutional challenges in similar proceedings to that of the SEC after Jarksey, leading to disruption of administrative enforcement across the Circuit Courts.