ADMINISTRATIVE LAW

Will the Supreme Court Run a Wrecking Ball Through Agency Adjudication?

 CASE AT A GLANCE

This case concerns the Securities and Exchange Commission’s (SEC’s) ability to bring enforcement actions for securities fraud before administrative law judges, rather than in federal district court. The target of an enforcement action argues this venue choice stems from an unconstitutional delegation of legislative power to the SEC and that the proceeding violates the Seventh Amendment right to a jury trial. In U.S. Securities and Exchange Commission v. Jarkesy, the Court has the potential to change the way government agency claims are adjudicated.

U.S. Securities and Exchange Commission v. Jarkesy 
Docket No? 22-859

Argument Date: November 29, 2023 From: Fifth Circuit

by Elizabeth Slattery 
Pacific Legal Foundation, Arlington, VA

Issues

There are three questions before the Supreme Court:

1. Does the federal law empowering the Securities and Exchange Commission (SEC) to initiate and adjudicate administrative enforcement proceedings seeking civil penalties violate the Seventh Amendment?
2. Does the federal law authorizing the SEC to choose to enforce the securities laws through an agency adjudication instead of filing a district court action violate the nondelegation doctrine?
3. Did Congress violate Article II by granting for-cause removal protection to administrative law judges (ALJs) in agencies whose heads enjoy for-cause removal protection?

Facts
 

The SEC is charged with enforcing a variety of securities laws. For much of the SEC’s history, it could only seek to impose civil penalties by bringing an action in federal district court. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 changed this"by authorizing the SEC to bring actions seeking civil penalties in administrative enforcement proceedings against regulated entities. The Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 expanded the SEC’s authority to bring actions for civil penalties against entities that it does not regulate either in federal district court or administrative enforcement proceedings.

When the SEC institutes an administrative enforcement proceeding, an ALJ is assigned to preside, act as fact finder, and make a determination. The number of SEC ALJs has fluctuated over the last decade; it previously had six ALJs, and currently there are two. The proceeding is similar to a trial except that many of the hallmarks of due process are absent: there is no jury, there is no discovery, the evidentiary rules are relaxed, and guilt is determined by a preponderance of evidence. Either side may appeal the ALJ’s decision to the SEC commissioners, and the SEC’s final decision may be appealed to a federal appeals court. The appeals court may only reverse the SEC’s ruling if the findings were unsupported by “substantial evidence” in the record.

"George Jarkesy set up two hedge funds and used Patriot28, LLC, as the investment adviser. The funds had more than 100 investors and about $24 million in assets. The SEC launched an investigation into Jarkesy and Patriot28’s investing activities in 2011, which led to the agency charging them with securities fraud in an in-house adjudication. The SEC alleged that Jarkesy and Patriot28 made several misrepresentations and overvalued the funds’ assets to increase fees they charged investors. Jarkesy and Patriot28 sued in federal district court to enjoin the agency proceedings for violating their constitutional rights to due process and a jury trial, among others. The district and appeals courts denied them injunctive relief, so the adjudication proceeded.

After holding an evidentiary hearing, the ALJ held Jarkesy and Patriot28 committed securities fraud. They petitioned the SEC to review that decision. While their petition was pending, the Supreme Court ruled in Lucia v. SEC, 138 S. Ct. 2044 (2018), that SEC ALJs are officers of the United States who must be appointed according to the Appointments Clause of the Constitution. The SEC then ratified the appointment of its ALJs and sent Jarkesy and Patriot28 back to a properly appointed ALJ. They waived their right to a new hearing and continued under the original petition. After rejecting Jarkesy and Patriot28’s arguments concerning various constitutional defects of the adjudicative process, the SEC agreed with the ALJ’s ruling and ordered them to pay a $300,000 civil penalty, required Patriot28 to disgorge just under $685,000 in “ill- gotten gains,” and barred Jarkesy from engaging in several securities-related activities.

Jarkesy and Patriot28 filed a petition for review with the U.S. Court of Appeals for the Fifth Circuit. A three-judge panel held that the SEC’s adjudication violated Jarkesy and Patriot28’s Seventh Amendment right to a jury trial. The Seventh Amendment guarantees the right of trial by jury in “Suits at common law,” and the Supreme Court has interpreted this to include actions that “seek[] common-law-like legal remedies.” The panel explained that the fraud claims at issue are such an action (and are “quintessentially about the redress of private harms”), so Congress may not assign them to an administrative forum to avoid the Seventh Amendment’s requirement of a jury trial.

The panel also held Congress delegated legislative power to the SEC without an intelligible principle to guide the agency’s exercise of that power in violation of the Constitution’s nondelegation principle. The panel reasoned" "that giving the SEC the choice between bringing an action in federal court and an administrative proceeding amounted to allowing the SEC to decide which defendants receive greater due process protections afforded by federal courts. Such a choice, the panel concluded, is an exercise of legislative power that Congress may not constitutionally assign to the SEC. Finally, the panel held that restrictions on the ability to remove SEC ALJs from office violate Article II of the Constitution. The panel explained that since ALJs may only be removed from office by SEC commissioners for “good cause” as determined by the Merit System Protection Board (MSPB) (with SEC commissioners and MSPB members also enjoying tenure protection), ALJs have two levels of tenure protection that prevents the president from adequately controlling and supervising them.

A dissenting judge maintained that the Seventh Amendment does not prohibit Congress from assigning cases involving public rights created by statute (such as the various securities statutes that empower the SEC to protect investors from fraud) to an administrative forum, rather than a jury trial. The dissent contended that allowing the SEC to choose between two venues is an exercise of prosecutorial discretion, so it does not violate the Constitution’s nondelegation principle. The dissent also explained that since ALJs perform an adjudicative function, rather than enforcement or policymaking ones, restrictions on their removal do not violate the Constitution. The Fifth Circuit en banc declined a petition to rehear the case, over the dissent of six judges. The SEC filed a petition for a writ of certiorari, and the Supreme Court granted it and scheduled the case for oral argument on November 29, 2023.

Case Analysis
 

The SEC first argues that its adjudicative proceedings do not violate the Seventh Amendment because they involve public rights, rather than private rights. Prior Supreme Court cases permit Congress to assign adjudication of claims involving public rights to agencies. While the line between public and private rights has not been “definitively explained[,]” when Congress creates “new statutory obligations, impose[s] civil penalties for their violation, and then commit[s] to an administrative agency the function of deciding whether a violation has in fact occurred,” the SEC asserts, that falls on the public-rights side of the line. The SEC further argues that the securities laws are distinguished from the common law because" "they allow the SEC to seek civil penalties even if no one has been harmed. Thus, a violation of the securities laws “is committed against the United States rather than an aggrieved individual,” and when the SEC seeks civil penalties “it acts in the public interest, to remedy harm to the public at large.” Next, the SEC maintains that Congress did not violate the nondelegation principle when it authorized it to choose between bringing charges in federal court or an administrative proceeding. Such a choice is an exercise of enforcement discretion, which is a “core executive power that stems from the President’s authority to ‘take Care that the Laws be faithfully executed.’” There is “no constitutional difference” between the power to decide “whether to bring an enforcement proceeding… and where to bring it.” (emphasis in original). The Constitution prohibits Congress from delegating to the other branches “powers which are strictly and exclusively legislative.” The SEC notes that the lower court conflated Congress’s authority to determine a range of permissible enforcement mechanisms with the agency’s authority to select one such mechanism in an individual case.

Finally, the SEC contends that its ALJs’ tenure protection does not violate the Constitution. Unlike the board members at issue in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010) (invalidating board members’ two layers of removal protection), ALJs serve an adjudicative function, not a policymaking one. Thus, ALJs have “a distinctive need for decisional independence[]” from the SEC to “enhance the actual and perceived fairness” of their proceedings. The SEC also points out that Congress has protected ALJs from at-will removal since the passage of the Administrative Procedure Act in 1946. Jarkesy and Patriot28 argue that the Seventh Amendment requires securities-fraud claims for civil penalties to be brought in federal district court with a jury. Allowing an agency to adjudicate such legal claims conflicts with the English common-law tradition and the original understanding of the Seventh Amendment. Jarkesy and Patriot28 contend that the SEC’s position would “eviscerate[e]…jury trial rights whenever an agency…sues a citizen under a claim contained within a federal statute.” While disputes concerning government benefits and franchises, where “the government is the real party in interest,” may be assigned to an administrative forum," "fraud actions for civil penalties, where a defendant is deprived of his property, must be heard by a federal district court with a jury.

Turning to the nondelegation issue, Jarkesy and Patriot28 contend that the ability to assign statutory claims to an administrative forum is “exclusively within Congress’ control” and shifting that authority to the SEC “without any criteria” to guide it in its exercise of that power is a “textbook violation” of the nondelegation principle. Last, Jarkesy and Patriot28 maintain that the Court has recognized “a singular, narrow exception” to the president’s power to remove executive officers, and SEC ALJs are not officers with “limited duties and no…administrative authority.” Since the ALJ who handled their adjudication was improperly insulated from presidential control, Jarkesy and Patriot28 argue that the SEC’s final order must be set aside.

Significance
 

This case could have significant implications for administrative agencies. A finding that the SEC’s adjudication of fraud claims violated the Seventh Amendment right to a jury trial could expose other agencies that adjudicate fraud claims, such as the Department of Health and Human Services, the Federal Energy Regulatory Commission, and the Department of Labor, to constitutional challenge. Congress’s decision to allow the SEC to choose between bringing actions in federal court or adjudication is relatively rare, so a holding that this violated the nondelegation principle likely would not have wide-ranging implications. Nevertheless, such a ruling could put wind in the sails of an effort to reinvigorate the nondelegation principle that has stalled the past few years. A ruling invalidating tenure protection for SEC ALJs could affect the ALJs at other independent agencies, such as the Social Security Administration’s 1,500 ALJs that hear over 300,000 cases per year."

ATTORNEYS FOR THE PARTIES

For Petitioner Securities and Exchange Commission

(Elizabeth B. Prelogar, Solicitor General, 202.514.2217)

For Respondents George R? Jarkesy, Jr?, et al? (Sidney Michael McColloch, 214.674.1868)

AMICUS BRIEFS

In Support of Petitioner Securites and Exchange Commission

• Administrative Law Scholars (Alan B. Morrison, 202.994.7120)
• American Bar Association (Deborah Delores Enix-Ross, 312.988.5000)
• Association of Administrative Law Judges (Hyland Hunt, 202.868.6915)
• Federal Administrative Law Judges Conference (Ronald William Chapman II, 248.644.6326)
• Jed H. Shugerman (Jeffrey Benjamin Dubner, 202.448.9090)
• National Treasury Employees Union (Julie Marie Wilson, 703.352.3325)
• North American Securities Administrators Association, Inc. (Vincente Leon Martinez, 202.368.0419)
• Professors John M. Golden and Thomas H. Lee (Thomas H. Lee, 347.324.6000)
• Public Citizen (Allison M. Zieve, 202.588.1000)

In Support of Respondents George R? Jarkesy, Jr?, et al?

• Advancing American Freedom, Inc. (John Marc Wheat, 202.780.4848)
• America First Policy Institute (Richard Polk Lawson, 813.952.8882)
• American Bankers Association, American Association of Bank Directors, and Bank Policy Institute (Manuel G. Berrelez, 214.220.7709)
• Americans for Prosperity Foundation (Michael David Pepson, 571.329.4529)
• Anthony Michael Sabino (Anthony Michael Sabino, 516.294.3199)
• Atlantic Legal Foundation (Lawrence S. Ebner, 202.729.6337)
• Cato Institute (Anastasia Paulinna Boden, 202.216.1414)
• Chamber of Commerce of the United States, the National Federation of Independent Small Business Legal Center, Inc., and the Business Roundtable (Steven Andrew Engel, 202.261.3369)
• Claremont Institute’s Center for Constitutional Jurisprudence (Anthony Thomas Caso, 916.601.1916)
• Competitive Enterprise Institute (Charles Devin Watkins, 503.753.8104)
• Constitutional Originalists Edwin Meese III, Steven G. Calabresi, and Garry S. Lawson (Amit Ramnik Vora, 203.887.8158)
• David Julian (Matthew Theodore Martens, 202.663.6000)
• Energy Transfer LP (William S. Scherman, 202.256.7000)
• Independent Women’s Law Center (Kathryn Elizabeth Tarbert, 202.787.1060)
• Institute for Justice, Sun Valley Orchards, LLC, Procraft Masonry, LLC, and C.S. Lawn & Landscape, Inc. (Robert Everett Johnson, 703.682.9320)
• Liberty Justice Center (Loren Ariela Seehase, 312.637.2280)
• Morris & Dickson (Hashim M. Mooppan, 202.879.3744)
• New Civil Liberties Alliance (Margaret Ann Little, 202.869.5212)
• Phillip Goldstein, Nelson Obus, Mark Cuban, Elon Musk, Manouch Moshayedi, and Investor Choice Advocates Network (Nicolas Morgan, 213.683.6181)
• Pioneer Public Interest Law Center (Ashley C. Parrish, 202.737.0500)
• TotalEnergies Gas & Power North America, Inc. (Jeremy Charles Marwell, 202.639.6507)
• Washington Legal Foundation (John Mercer Masslon II, 202.588.0302)
• West Virginia and 17 Other States (Lindsay Sara See, 304.558.2021)
• CTIA–The Wireless Association, USTelecom–The Broadband Association, and the Competitive Carriers Association (Thomas Michael Johnson Jr., 202.719.4550)

In Support of Neither Party

• Andrew N. Vollmer (Andrew N. Vollmer, 703.993.8840)
• Forum of United States Administrative Law Judges (Steven Anson Glazer, 301.332.9214)
• Professor Ilam Wurman (Ilam Wurman, 480.965.2245)