Supreme Court Doesn’t Address SEC Courts’ Most Insidious Problems

As the US Supreme Court first waded into the Jarkesy v. US Securities and Exchange Commission debate a year ago about the constitutionality of the SEC’s administrative courts, I made some observations about the merits of the lower court’s rulings in the case and conflicts of interest inherent in SEC courts that, while important, don’t quite rise to the level of constitutional violations.

It looked then like the most glaring of those conflicts would remain unresolved no matter the outcome of the Supreme Court’s review. The original appeal was nonetheless important because it posed the most compelling challenge yet to the way the SEC and its administrative law judges have been handling SEC enforcement actions for as long as we can remember.

But I guessed the less sensational problems with the SEC’s administrative courts would probably go unaddressed, and they did. While the Supreme Court’s Jarkesy decision resolved one of the important constitutional questions raised in the appeal, it passed over the many procedural anomalies that have always plagued respondents stuck litigating in the SEC’s courts.

Jarkesy was a routine SEC enforcement action against the founder of two hedge funds involving misstatements in the funds’ offering materials. After he exhausted his options before the SEC’s ALJ and lost his appeal to the SEC itself, George Jarkesy appealed to the US Court of Appeals for the Fifth Circuit.

The appellate court saw things Jarkesy’s way and held that the SEC’s ALJ program violates three different protections of the US Constitution: the Seventh Amendment’s right to a jury trial, the prohibition in Article I on excessive delegation of Congress’ legislative power, and the restrictions in the “take care” clause of Article II as applied to the removal of ALJs.

The Supreme Court answered the Seventh Amendment question—probably the most important of the three—but declined to rule on Jarkesy’s challenges based on excessive delegation and the “take care” clause.

On the Seventh Amendment issue, the court largely affirmed the appellate court, holding that Jarkesy was entitled to a jury trial on his securities fraud claims because the civil monetary penalties the SEC sought were “a type of legal remedy at common law that could only be enforced in courts of law.”

The remedy falls within the protection of the Seventh Amendment, which guarantees that, in suits at common law “the right of trial by jury shall be preserved.” In the end, though, the decision was the product of a workaday application of unremarkable Supreme Court precedent.

SEC Status Quo

Despite all the handwringing over possible implications of the decision for the SEC, the June 27 ruling didn’t do anything to correct the more prosaic, but more insidious, problems with the SEC’s ALJ program. For example, after Jarkesy the SEC’s five commissioners will still get first crack at appellate review of ALJ proceedings in which the SEC is itself an interested party—including future jury trials, but also all other litigation where the SEC comes out the loser.

Even in cases where no party challenges the outcome of an SEC administrative proceeding, the SEC will still be authorized to review, on its own initiative, any ALJ decision it doesn’t like. And in any proceeding where the SEC is a litigant, ALJs will still be obligated to follow Commission-authored (and, many would say, pro-SEC) case law in deciding disputes. None of these things can happen when the SEC litigates its cases in the parallel federal court system.

Lurking behind these arcane procedural realities is the concern that nothing can ever neutralize the confirmation bias the SEC brings when it sits as an appellate body reviewing the results of its own enforcement cases.

Human nature suggests the commissioners will always find it difficult to evaluate impartially ALJ decisions where the SEC has a stake, as federal appellate courts, which have no involvement in the underlying disputes they are asked to review, can do. That built-in bias should strike disinterested observers as problematic.

But the Supreme Court’s Jarkesy decision wasn’t a wash, either. The Seventh Amendment question was important in itself, and the case was a bellwether for securities lawyers and market participants who cared how a conservative Supreme Court would respond to the spate of recent Fifth Circuit decisions challenging the SEC’s usual modus operandi.

Jarkesy provided a partial answer: The Supreme Court is receptive to challenges to core agency processes, even if those challenges result in the upending of substantive administrative procedures that have been in place for decades.

This bodes well (depending on which side you take in the debate) for the Supreme Court’s likely review of the Fifth Circuit’s recent demolition of the SEC’s private fund adviser rule. The answer was only partial, though. The SEC’s in-house courts are still riddled with procedural inequities that Jarkesy didn’t touch. Those issues will have to await another George Jarkesy who is willing to spend the money and time to challenge the old SEC verities and, perhaps, a future Supreme Court that’s willing to take those challenges seriously.

The case is SEC v. Jarkesy, U.S., No. 22-859, decided 6/27/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

David Slovick is partner at Barnes & Thornburg and was previously a senior attorney at the Securities and Exchange Commission.

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