As I noted in a blog post at the time, in June the U.S. Supreme Court entered its opinion in the SEC v. Jerkesy case, striking down the SEC’s use of Administrative Law Judges in civil penalty action. In the following guest post, Gregory Markel, Sarah A. Fedner, and Gershon Akerman of the Seyfarth Shaw law firm take a detailed look at the case and consider its significance and implications. A version of this article previously was published in the Practical Law Forum. I would like to thank the authors for allowing me to publish their article on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.

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In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) endowed the SEC with almost absolute discretion as to whether to bring its enforcement actions in federal court or in administrative proceedings. Respondents in administrative actions have since repeatedly challenged the SEC’s powers in those proceedings as unconstitutional, and the Supreme Court has generally sided with these respondents. The Court found that SEC administrative law judges (ALJs) are officers of the US who are subject to the Appointments Clause of the Constitution and must therefore be appointed by the President, judiciary, or agency heads, leading the SEC to ratify the prior appointment of its ALJs and review pending proceedings (Lucia v. SEC, 585 U.S. 237 (2018); for more information, see SEC Staff’s Appointment of ALJs Unconstitutional: Supreme Court on Practical Law). The Court then held that federal district courts have jurisdiction to hear respondents’ structural constitutional challenges to the SEC’s administrative powers before first exhausting the administrative process (Cochran v. SEC, 138 S. Ct. 2044 (2018)); for more information, see Supreme Court Rules on Congress’s Implied  Preclusion of District Court Jurisdiction over Agency Enforcement Proceedings on Practical Law). The Court’s recent decision in SEC v. Jarkesy is the outcome of the latest of these challenges, and it might have the greatest effect on the future of administrative proceedings of any decision so far (144 S. Ct. 2117 (2024)).

How did the SEC conduct administrative proceedings before Jarkesy?

The SEC was founded in 1934 to regulate securities markets and protect the investing public. The Administrative Procedures Act of 1946 (APA) granted the SEC the authority to appoint and employ ALJs to conduct hearings and act as factfinders and arbiters of the law (5 U.S.C. § 3105).

Generally, the SEC has been able to bring its enforcement actions in administrative proceedings or in federal courts. Respondents in administrative proceedings could appeal the ALJ’s determination to the SEC, and only then to a federal court of appeals, which had limited authority to review the SEC’s determination (5 U.S.C. § 706(2)). Until recently, the SEC has also benefitted from Chevron deference, a doctrine dictating court deference to an agency’s interpretation of an ambiguous statute. However, the Supreme Court overruled this doctrine in Loper Bright Enterprises v. Raimondo (143 S. Ct. 2429 (2024); for more information, see Supreme Court Decision Overturning Chevron Deference in the August 2024 issue of Practical Law The Journal).

Counsel practicing SEC enforcement should also be aware of the Supreme Court’s decision overruling a long-standing Chevron deference doctrine (see Loper Bright Enterprises v. Raimondo, 143 S.Ct. 2429 (2024); see also Legal Update, Supreme Court Overrules Chevron Framework for Interpreting Laws Administered by Federal Agencies).

Chevron Deference Overruled

The Chevron doctrine was established in 1984, when the Supreme Court held that a federal court could only reverse an administrative agency’s (including the SEC’s) findings of fact where there is substantial evidence supporting such outcome (Chevron, U.S.A., Inc. v. Nat. Res. Defense Council, Inc., 467 U.S. 837 (1984)). Chevron thereby entitled the SEC’s determination of the securities laws to a substantial degree of deference in federal courts. The Loper decision expressly overruled Chevron. Under Loper, federal judges need not afford any deference to an agency’s interpretation of the law.

While the SEC has recognized the courts’ tendency to bypass Chevron and has generally refrained from invoking Chevron deference in its enforcement actions, counsel representing individuals and entities in SEC investigations should keep in mind that Loper may still reduce the SEC’s appetite for litigation. By the same token, counsel should consider whether their clients should be more willing to litigate post-Loper, especially in cases where the SEC seeks to impose exorbitant fines or threatens an enforcement action based on a novel interpretation of a statute.

Before 1990, the SEC generally was required to bring securities fraud claims and seek civil penalties in federal court. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 authorized the SEC to seek civil monetary penalties in administrative proceedings but only against the entities the SEC regulates (Pub. L. No. 101-429, 104 Stat. 931 (1990)).

In 2010, following the subprime financial crisis, the Dodd-Frank Act broadened the SEC’s powers to bring enforcement actions and seek civil monetary penalties in administrative proceedings also against unregulated entities. (Pub. L. No. 111-203, 124 Stat. 1376 (2010). The SEC has since brought an increasing number of its enforcement actions in administrative proceedings rather than in federal court and has had more success before ALJs than before federal judges and juries.

What is the factual and procedural background of Jarkesy?

In 2013, the SEC commenced an administrative proceeding against George Jarkesy, a hedge fund manager, for securities fraud. The SEC alleged that Jarkesy made false representations to his investors, including misrepresenting the funds’ investment strategies and overvaluing the funds’ holdings. 

Jarkesy initially filed a collateral action in district court to enjoin the administrative proceeding as unconstitutional. However, the district court dismissed the action for lack of jurisdiction, holding that he had to exhaust the administrative process before he could petition the court of appeals to review any adverse final decision. (Jarkesy v. SEC, 48 F. Supp. 3d 32, 40 (D.D.C. 2014), aff’d, 803 F.3d 9, 12 (D.C. Cir. 2015).)

After the ALJ found that Jarkesy committed securities fraud and imposed monetary and other penalties, Jarkesy appealed to the SEC, which affirmed the ALJ’s findings and penalties. Jarkesy then reasserted his constitutional objections in an appeal to the US Court of Appeals for the Fifth Circuit, which sided with him on three separate grounds (Jarkesy v. SEC, 34 F.4th 446, 449 (5th Cir. 2022)). The court held that:

• The use of administrative tribunals for enforcement of common law claims violated the respondent’s right to a jury trial under the Seventh Amendment (U.S. Const., Amend. VII).
• Congress violated the non-delegation doctrine by improperly delegating to the SEC broad discretionary authority to choose which enforcement cases to bring before its administrative tribunals and which to bring in federal court, without providing an intelligible principle to guide the SEC in making those determinations.
• Statutory provisions providing for a double layer of for-cause removal protection of the SEC’s ALJs violated the Take Care Clause of the Constitution. (Jarkesy, 34 F.4th at 451, 463-64.)

The SEC then filed a petition for a writ of certiorari, which the Supreme Court granted.

What did the Supreme Court hold in Jarkesy?

The Supreme Court affirmed the Fifth Circuit’s holding with regard to the Seventh Amendment, finding that the SEC’s decision to bring a securities fraud enforcement action and seek civil penalties in an administrative proceeding violated Jarkesy’s right to a jury trial (144 S. Ct. at 2127; for more information,  see Supreme Court Holds That Seventh Amendment Entitles a Defendant to a Jury Trial When the SEC Seeks Civil Penalties for Securities Fraud on Practical Law). The Court did not reach the two other constitutional issues raised by the Fifth Circuit.

Specifically, the Court held that the Seventh Amendment right to a jury trial applied to any common law claims that are legal in nature, defined as any claims that do not sound in equity or maritime or admiralty law. To determine whether a claim is legal in nature, a court should consider whether the cause of action resembles a common law cause of action and whether the remedy is the kind of remedy traditionally obtained in a court of law. The Court found that securities fraud was similar to common law fraud and that civil monetary penalties were a prototypical common law remedy because their purpose was to punish and deter, not restore the status quo.

The Court noted that the Seventh Amendment right to a jury trial is subject to the public rights exception, which allows Congress to assign certain matters to an agency rather than a jury. But the public rights exception is limited and applies only in areas traditionally determined by the executive and legislative branches as involving public rights. The exception does not apply to claims such as securities fraud, which resemble common law causes of action and involve private rights.

Will Jarkesy affect the SEC’s appetite to litigate securities fraud claims?

Jarkesy will likely have a significant impact on the SEC’s appetite and ability to litigate securities fraud claims going forward. As Justice Gorsuch noted in his concurrence, since the Dodd-Frank Act, the SEC has won significantly more of the enforcement actions it brought in administrative proceedings than those it brought in federal courts (Jarkesy, 144 S. Ct. at 2141 (Gorsuch, J., concurring)).

While Jarkesy left a number of open questions, it unequivocally required the SEC to bring securities fraud actions seeking civil penalties in federal court rather than in administrative proceedings. Therefore, Jarkesy will likely result in the SEC being more selective in its enforcement of securities fraud, primarily bringing the more serious fraud actions. The increase in resource usage required to bring an action in federal court will likely reduce the SEC’s ability to pursue smaller fraud cases, which may incentivize it to either settle those cases or bring lesser charges involving non-fraud claims and seek equitable remedies in administrative proceedings. This trend should provide an advantage to counsel representing entities or individuals in SEC investigations and settlement negotiations.

The requirement to bring fraud cases in federal court may increase fair outcomes for respondents due to stricter procedural and evidentiary standards and the right to a jury trial, as compared to the agency-friendly rules applicable in administrative proceedings. On the flipside, the SEC’s reduced ability to bring as many fraud cases may embolden bad actors and result in adverse consequences for the investing public.

Does Jarkesy restrict the SEC from litigating securities laws violations other than securities fraud in administrative proceedings?

It is unclear how broadly or narrowly the lower courts will interpret Jarkesy or what position the SEC will initially take concerning its ability to litigate non-fraud claims in administrative proceedings. Jarkesy’s ruling suggests that the Seventh Amendment may apply to actions involving any claims that resemble common law claims in which the SEC seeks civil monetary penalties, unless it is subject to the public rights exception.

Therefore, post-Jarkesy, the SEC may be able to commence an administrative proceeding in actions where either:

• It seeks an equitable remedy, such as disgorgement or injunctive relief.
• Public rights are at issue, such that the action is excepted from the Seventh Amendment.

In practice, it is unlikely that the SEC would limit itself to seeking only equitable relief, even for non-fraud violations, except in relatively minor cases or where the respondent provides extraordinary cooperation with the SEC’s investigation. It is important to note that the SEC’s imposition of disgorgement is equitable, not punitive, only where it is limited to:

• Situations where the disgorged funds can be returned to the aggrieved investors, not deposited to the US Treasury.
• The specific defendant’s profits, rather than all profits allegedly received from the illegal conduct.
• Amounts that account for the deduction of legitimate business expenses, even if the aim of the scheme was to defraud.

(Liu v. SEC, 591 U.S. 71 (2020); for more information, see SEC May Obtain Disgorgement Subject to Certain Equitable Principles: Supreme Court on Practical Law).

While the Jarkesy majority stated that there is a public rights exception to the Seventh Amendment’s right to a jury trial, it acknowledged that the Court has not drawn clear contours of the exception. However, the Court did provide several instances when historically it deemed certain actions involving public rights as excepted from the protections of the Seventh Amendment.

Importantly, the Court carefully distinguished, but did not overrule, its decision in Atlas Roofing Co. v. Occupational Safety & Health Review Commission, where it held that the Seventh Amendment did not extend to the Occupational Safety and Health Review Commission’s in-house proceedings even when it imposed civil penalties for workplace safety violations, because those claims involved public rights that did not exist at common law (430 U.S. 442 (1977)).  

By affirming that Atlas Roofing remains good law, the Court arguably suggested that the public rights exception to the Seventh Amendment is broader than traditionally understood. This may have given new life to the SEC’s administrative proceedings. It remains to be seen what, if any, novel types of claims might qualify as involving public rights. 

We expect counsel representing respondents before the SEC to endorse a broad reading of Jarkesy and argue that the SEC must bring any enforcement actions in which it seeks civil penalties in federal court, not in administrative proceedings. The SEC will almost certainly counter by pointing to the Court’s unwillingness to overrule Atlas Roofing and arguing that it is constitutionally permitted to seek monetary penalties in administrative proceedings for statutory non-fraud claims, such as books and records claims, because they involve public rights. While it is difficult to determine exactly where courts will draw the line between private and public rights, counsel should keep in mind that since the Dodd-Frank Act’s enactment, the Supreme Court has exhibited substantial separation-of-powers concerns regarding the SEC’s administrative adjudication. 

Does Jarkesy affect the SEC’s ability to settle actions in administrative proceedings, including securities fraud actions?

Jarkesy involved contested enforcement proceedings and did not address the issues arising when parties settle with the SEC.

Generally, a respondent may freely agree to waive its right to a jury trial as part of a settled resolution, just as it can agree to an imposition of civil monetary penalties. Accordingly, Jarkesy should not hinder the SEC’s ability to settle any claims involving any remedies in administrative proceedings. However, in securities fraud enforcement actions where the SEC seeks a monetary penalty, defense counsel should consider using the fact that the SEC cannot litigate their case in administrative proceedings as leverage in settlement negotiations.

If the SEC settles fraud claims in administrative proceedings, the result is not likely to be challenged unless a defendant seeks to undo the settlement. In that scenario, the courts may conceivably get involved, though it remains unclear whether they may interpret any principles articulated in Jarkesy as requiring a federal judge’s approval of a settlement.

How else might Jarkesy affect the SEC’s enforcement regime?

Jarkesy will likely affect SEC enforcement in several other ways, including that:

• The SEC will now have to undertake a comprehensive review of its administrative enforcement and proceedings system and evaluate its ability to prosecute non-fraud violations in its in-house administrative tribunals, and the potential risks of doing so.
• Because enforcing securities violations in the SEC’s in-house administrative tribunals is generally less costly than bringing an action in federal court, Jarkesy will likely stress the SEC’s budget and its limited resources and cause the SEC (and other agencies that use in-house administrative tribunals) to be more focused and strategic in determining what fraud claims to prosecute.
• The SEC may be more willing to settle smaller fraud cases for lower fines and other penalties, possibly giving more leverage to defense attorneys representing parties in settlement negotiations with the SEC.
• The additional two constitutional objections the Jarkesy Court did not reach arguably remain good law in the Fifth Circuit. The SEC will have to face these challenges soon in other courts and circuits. Depending on the political climate, Congress may be able to address those constitutional objections by reducing or altogether eliminating removal protections for ALJs and providing a rational principle for the SEC’s choice of forum for its enforcement actions.

Will Jarkesy affect FINRA enforcement?

The Financial Industry Regulatory Authority (FINRA) investigates securities violations and brings enforcement proceedings, including imposing sanctions and fines, through its own in-house Office of Hearing Officers. Not surprisingly, a broker that FINRA sanctioned through a disciplinary action, which is an adjudication mechanism similar to an administrative proceeding, filed a lawsuit just days after the Jarkesy decision, arguing that FINRA’s disciplinary actions are unconstitutional (Verified Complaint, Blankenship v. FINRA, No. 24-3003 (E.D. Pa, July 10, 2024)). While it remains to be seen how the situation will evolve in this and future FINRA actions, we expect to see further challenges by brokers and member firms to FINRA’s ability to conduct disciplinary actions.

What effect might Jarkesy have on other administrative agencies’ enforcement?

Jarkesy may have broad implications and impact the behavior of other federal agencies, particularly those that often or exclusively use their own in-house administrative tribunals to adjudicate enforcement proceedings or seek to promulgate their own rules and guidelines on policy matters. As the SEC argued in its petition for certiorari, the Fifth Circuit’s opinion threatened to “cast a cloud” on all federal agencies that use in-house administrative tribunals for civil enforcement.

There are more than two dozen federal agencies that make use of their own in-house administrative tribunals for various purposes, such as the Commodity Futures Trading Commission, Department of Agriculture, Federal Energy Regulatory Commission (FERC), and others (see Jarkesy, 144 S. Ct. at 2173 (Sotomayor, J., dissenting)). For some agencies, such as FERC, the only enforcement path is through administrative proceedings. Defense counsel representing respondents before these agencies will certainly argue that the Jarkesy framework applies to actions against their clients and that their clients are entitled to an Article III court and a jury trial. Restoring this potentially dramatic reduction in administrative powers may require some sort of congressional action, including possibly a new mandate.

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Gregory Markel is chair of the Seyfarth Shaw law firm’s New York Litigation group, co-chair of the Securities and Fiduciary Duty Litigation group, and a member of the firm’s National Litigation Leadership Team. He is nationally recognized as a leading trial lawyer for complex commercial cases, including matters involving securities, director and officer liability, corporate governance, derivatives, mergers and acquisitions, and antitrust issues. Greg also has experience serving as an expert witness and arbitrator.

Sarah A. Fedner is a senior associate in Seyfarth Shaw’s Commercial Litigation and Securities Litigation groups and serves as the New York office representative on Seyfarth’s Litigation Associate Advisor Committee. She has successfully represented special committees, individual officers, and directors of large publicly traded corporations in federal and state courts, as well as in regulatory and internal investigations. Sarah has been recognized by Best Lawyers as One to Watch in Securities Litigation.

Gershon Akerman is an associate at Seyfarth Shaw LLP.  Gershon partners with clients on an array of commercial litigation, business disputes, real estate-related litigation, and other civil litigation matters, including complex real estate and partnership disputes, consumer fraud class actions, false advertising claims, tax lien foreclosures, and bankruptcy and creditors’ rights. He also has extensive experience representing educational and other institutions in actions brought under the New York Child Victim Act.