On May 18, 2022, a divided panel of the U.S. Court of Appeals for the Fifth Circuit issued a significant decision in George Jarkesy and Patriot28 LLC v. SEC, ruling that the use of administrative proceedings by the Securities and Exchange Commission (“SEC”) was unconstitutional because, among other reasons, the Court found that Congress impermissibly delegated the decision of whether to bring enforcement actions as administrative proceedings or district court actions without providing adequate guidance to the SEC. The decision is limited to the Fifth Circuit and will undoubtedly be appealed, but it raises significant questions about the use of administrative proceedings even beyond the SEC.
The case involved two petitioners, George Jarkesy, who established two hedge funds, and Patriot28, which was the funds’ investment adviser. The SEC accused them both of engaging in securities fraud by, for example, misrepresenting who served as prime broker, misrepresenting the funds’ investment parameters and safeguards, and overvaluing the funds’ assets. Rather than file a lawsuit action in U.S. District Court, the SEC initiated contested administrative proceedings that ultimately resulted in (1) cease and desist orders; (2) an order that Jarkesy pay a $300,000 civil penalty; (3) an order that Patriot28 pay $685,000 in disgorgement; and (4) industry and officer and director bars.
On appeal, the Fifth Circuit ruled that the SEC proceedings suffered from three independent constitutional defects: (1) Petitioners were deprived of their right to a jury trial; (2) Congress unconstitutionally delegated legislative power—specifically, the decision on whether to initiate administrative proceedings or district court actions in a given case—without an intelligible principle by which to exercise that delegated power; and (3) statutory removal restrictions on SEC administrative law judges violate Article II.
On the first point, Fifth Circuit panel concluded that, at least for the securities fraud claims at issue, petitioners were constitutionally entitled to a trial by jury. The panel did not hold (and did not need to hold) that there are no enforcement actions where the right to a jury trial would not extend, but for securities fraud actions where penalties are sought, the panel held that the jury right was absolute. The SEC had argued that, as a government agency, they are pursuing “public rights” for which no right to a jury trial extends. But the panel concluded that such an argument proves too much and stated that “because the SEC’s enforcement action is akin to traditional actions at law to which the jury-trial right attaches,” the Seventh Amendment guaranteed petitioners a right to a jury. Specifically, the panel focused on the fact that the proceedings sought legal remedies (in the form of civil penalties) as well as equitable remedies (in the form of disgorgement and forward-looking industry bars). Had there been no civil penalty sought or obtained, the panel may thus have ruled differently, but in a fraud action where a civil penalty is sought, the panel concluded that respondents have a right to a jury.
The most interesting—and potentially broadest—aspect of the Court’s decision was the panel’s conclusion that Congress impermissibly delegated to the SEC the decision of whether to bring a given enforcement action as a civil proceeding in U.S. District Court or as an administrative proceeding. There is no question that Congress delegated such authority to the SEC, and it has reaffirmed that delegation in recent years (such as through the Dodd-Frank Act). But the panel held that Congress has never provided adequate guidance to the SEC as to how their discretion should be exercised, rendering the delegation unconstitutional.
As explained by the panel, the SEC had argued that “by choosing whether to bring an action in an agency tribunal instead of in an Article III court it merely exercises a form of prosecutorial discretion—an executive, not legislative, power.” The panel disagreed, holding that Congress “effectively gave the SEC the power to decide which defendants should receive certain legal processes (those accompanying Article III proceedings) and which should not. Such a decision—to assign certain actions to agency adjudication—is a power that Congress uniquely possesses.” There have long been questions raised about whether, in an individual case, the SEC acts arbitrarily and capriciously when deciding whether to proceed through an administrative proceeding or district court action; but this decision frames the issue in a new and significant way – that because Congress did not provide an “intelligible principle” to guide how such decisions should be made, the delegation itself is unconstitutional.
As the dissent in Jarkesy points out, this holding has potentially broader implications for exercise of agency discretion beyond the question of the selection of an adjudicative forum: in analyzing a lower court’s ruling in another SEC enforcement case, the dissent noted that, if the term “legislative action is interpreted broadly and out of context, then any SEC decision which affected a person’s legal rights—including charging decisions—would be legislative actions” and thus subject to the “intelligible principle.” Viewed in that light, Jarkesy could be a harbinger of additional rulings aimed at reducing the SEC’s exercise of its discretionary authority.
The Supreme Court has historically been hesitant to strike down administrative delegations for lack of an “intelligible principle,” but this decision could nevertheless provide a meaningful opportunity to revisit how administrative delegations are made.
Finally, as noted above, the panel decision also held that the statutory removal restrictions for SEC ALJs are unconstitutional. This aspect of the decision is, in some respects, a continuation of the back-and-forth litigation that spawned the Supreme Court’s decision in Lucia v. SEC, 138 S. Ct. 2044, 2053 (2018) (holding that SEC ALJs are “inferior officers”), and the SEC’s efforts to appoint ALJs in a manner that will be deemed satisfactory by the Supreme Court.
Taken together, the holdings raise significant implications for the SEC’s use of administrative proceedings, which could extend to other agencies as well. At the same time, the decision is limited to only one circuit, and will surely be the subject of either a petition for en banc review or a petition for certiorari. Accordingly, we fully expect that there will be additional litigation on each of these topics.
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George Jarkesy and Patriot28 LLC v. SEC
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