Prior to the ruling, the SEC could initiate and adjudicate enforcement proceedings seeking civil penalties for violations of the securities laws in one of two forums: an administrative proceeding at the SEC or in federal court. When the SEC adjudicates matters in administrative proceedings, it “acts as both prosecutor and judge,” with the Commission presiding over the case while its Division of Enforcement prosecutes it. Jarkesy v. SEC, 34 F.4th 446, 449 (5th Cir. 2022). The Commission or its delegee, typically an Administrative Law Judge (ALJ) employed by the SEC, serves as the fact finder, the SEC’s Rules of Practice govern the proceeding, and discovery is limited. By contrast, in federal court, a federal judge appointed by the President presides over the proceedings, a jury finds the facts, and the broad U.S. discovery rules and the Federal Rules of Evidence apply. 

Prior to Jarkesy, the SEC had the unilateral authority, delegated to it by Congress, to select between these two forums when bringing an enforcement action seeking civil penalties. And this choice of forum mattered. According to one report, the SEC won about 90% of its contested administrative proceedings compared to 69% of its cases in court. D. Thornley & J. Blount, SEC In-House Tribunals: A Call for Reform, 62 Vill. L. Rev. 261, 286 (2017). Administrative proceedings are also more efficient. SEC regulations mandate an administrative hearing on the merits within ten months of service of the charges. 17 CFR §201.360(a)(2)(ii). In federal court, by contrast, getting to trial typically takes years, affording defendants ample time to prepare their defense but also driving up costs for both sides. Given these obvious advantages, it is no wonder that after the passage of the Dodd-Frank Act in 2010, which, for the first time, permitted the SEC to seek civil penalties in administrative proceedings, the SEC began to select this forum for most of its cases. It was only recently, after the constitutionality of the hearings was called into question that the SEC started to bring many cases in federal court again. 

Procedural History in SEC v. Jarkesy
In 2013, the SEC brought an administrative action against investment adviser George R. Jarkesy, Jr. and Patriot28, LLC, which served as the adviser to two hedge funds set up by Jarkesy in 2007. The SEC alleged that Jarkesy and Patriot28 committed fraud under federal securities laws by misrepresenting the identity of the funds’ prime broker and auditor, misrepresenting the funds’ investment parameters and safeguards, and overvaluing the funds’ assets to increase the fees that they could charge investors. 

Following an evidentiary hearing, the ALJ concluded that Jarkesy and Patriot28 had committed securities fraud. The SEC affirmed the ALJ’s findings and ordered Jarkesy and Patriot28 to pay a civil penalty of $300,000; it also ordered Patriot28 to disgorge nearly $685,000. Jarkesy and Patriot28 filed a petition for review of the SEC’s decision with the Fifth Circuit, arguing (among other things) that the administrative proceeding violated Jarkesy’s and Patriot28’s right to a jury trial under the Seventh Amendment. A divided panel of the Fifth Circuit held that the administrative proceedings suffered from three constitutional defects (described in our prior blog post) and vacated the SEC’s decision. The SEC filed a petition for certiorari with the U.S. Supreme Court. 

The SCOTUS Ruling 
SCOTUS ruled 6-3 in favor of Jarkesy and Patriot28. According to the majority, the case posed “a straightforward question”: whether the Seventh Amendment, which protects the right to a jury trial “in Suits at common law,” entitles a defendant to a jury trial when the SEC seeks civil penalties against him for securities fraud. The majority analyzed this question by applying a two-step inquiry, examining (1) whether the enforcement action implicates the Seventh Amendment and (2) whether the so-called “public rights” exception applies. 

As to the first inquiry, the majority found that the securities fraud claims against Jarkesy and Patriot28 implicated the Seventh Amendment, explaining that it extends to claims “legal in nature.” To determine whether a claim is legal in nature, courts consider whether the cause of action resembles common law causes of action and whether the remedy is the sort that was traditionally obtained in a court of law. Of these two factors, the remedy is the more important.

Here, the majority found the nature of the remedy sought—civil penalties— was “all but dispositive.” Examining the civil penalties provisions of the Securities Act, the Securities Exchange Act, and the Investment Advisers Act, the Court concluded that the penalties under these acts are designed to punish and deter, not compensate, and thus are “legal in nature.” The Court bolstered its conclusion by highlighting the close relationship between the claims brought against Jarkesy and common law fraud. 

Next, the Court addressed the public rights exception. According to the Court, the public rights exception permits Congress to assign the prosecution of actions that address certain categories of “governmental prerogatives” to an agency tribunal without a jury: the collection of revenue, customs enforcement, immigration, tribal relations, the administration of public lands, and the grant of public benefits. Because the anti-fraud provisions of the federal securities laws at issue do not fall within one of those categories, and because the anti-fraud provisions are similar in substance to, and target the same conduct as, common law fraud, the majority held that the public rights exception did not apply. 

Implications
Jarkesy is significant for individuals and companies facing allegations of securities fraud. Now, if the SEC wishes to seek civil penalties for alleged securities fraud, it can only do so in federal court. Gone are the days when the SEC could unilaterally choose to bring such claims to its in-house adjudicators. 

The decision in Jarkesy provides several benefits to defendants, including proceedings before a neutral judge, verdicts by an impartial jury, and an expansive body of federal rules that, among other things, allow for discovery and govern the admissibility (or inadmissibility) of evidence. Federal courts will also apply well-accepted precedents to the relief sought, which should result in lower penalties and fewer injunctions. Conversely, federal court litigation is likely to be longer and more resource-intensive for both the SEC and defendants. 

Defendants who do not prevail in district court will also have the ability to appeal without fear of retribution. Before Jarkesy, when a defendant appealed an administrative decision, it first went to the SEC, and the SEC often punished the defendant with even harsher penalties. Pursuing an appeal in federal court will not present the same risk.