On June 27, 2024, in a 6-3 decision, the Supreme Court held in SEC v. Jarkesy that the Securities and Exchange Commission ("SEC" or the "Commission") could not bring enforcement actions before intra-agency administrative law judges ("ALJs") to seek civil penalties against individuals accused of violating the anti-fraud provisions of the federal securities laws. This decision significantly impacts the Commission's ability to rely upon its in-house staff of ALJs to resolve enforcement actions in Administrative Proceedings. Ultimately, this represents a positive outcome for those who find themselves forced to defend SEC allegations that they have violated the federal securities laws as the intra-agency enforcement process favors the Commission in a number of ways, provides lower-quality process than federal courts, and insulates the Commission from needing to explain to a jury why their cases are important.

Seventh Amendment Right to Trial by Jury

The Court's reasoning turned on its application of the two-part test established in Granfinanciera, S.A. v. Nordberg[1] and Tull v. United States[2] regarding the right to trial by jury as guaranteed by the Seventh Amendment: (1) does the nature of the SEC's action implicate the Seventh Amendment; and (2) does the "public rights" exception to the Seventh Amendment apply?

Answering the first question in the affirmative, the Court reasoned that actions for fraud under the federal securities law implicate the same theories as common law fraud, and suits in common law are expressly entitled to trial by jury pursuant to the Seventh Amendment. The Court focused heavily on the nature of the remedy implicated by a civil penalty. The Court explained that the SEC's criteria involved in determining the applicability and amount of any civil penalty is "designed to punish and deter, not to compensate," which the Court viewed as akin to a "type of remedy at common law that could only be enforced in courts of law" and, therefore, entitled to the protections of the Seventh Amendment.

With respect to the second factor – the public rights exception to the Seventh Amendment – the Court held that the SEC's enforcement of the antifraud provisions of the federal securities laws did not fall within this exception. While noting that it was declining to "definitively explain" what qualified for the exception, the Court emphasized the exception's narrow application and its view that the antifraud provisions of the federal securities laws strongly resembled common law fraud.

The Court noted that it was deciding the case solely on the basis of the Seventh Amendment. It closed by stating its belief that "[a] defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator" and not be subjected to penalties imposed by the agency functioning as "prosecutor, judge, and jury[.]" This raises the question whether the decision invalidates the use of ALJs by any agency to adjudicate fraud-based claims.

Practical Implications

While the Commission had already begun to move away from enforcing securities laws violations through its intra-agency ALJs, the Jarkesy decision places significant limitations on the SEC's ability to pursue future enforcement actions through administrative proceedings. The Court's significant focus on the SEC's imposition of civil penalties also raises questions as to whether the Commission could pursue other remedies, such as disgorgement of allegedly ill-gotten gains or bars on serving as a corporate officer, before its ALJs. In Kokesh v. SEC[3] for example, the Court held that disgorgement qualifies as a penalty for the purpose of assessing the applicable statute of limitations. If disgorgement is a penalty akin to the punitive nature of civil penalties that animated the Court's holding in Jarkesy, then the SEC might be compelled to bring actions seeking disgorgement in federal court.

We anticipate that the sharp decline in the Commission's use of ALJs will become a permanent feature of its enforcement efforts post-Jarkesy. We view this as a positive development for those who may find themselves subject to an SEC enforcement action, as Administrative Proceedings before the Commission's ALJs lack substantial procedural safeguards that litigants can avail themselves of in federal court, beyond being deprived of a right to a jury trial. For example, hearsay is admissible as evidence in administrative proceedings. SEC enforcement teams will now be required to think through their standard of proof from the jury's perspective, rather than simply aim to force a quick settlement through an Administrative Proceeding process that provides comparably few protections for private parties.

Although Jarkesy involved the SEC's intra-agency process, its holding may also have a significant impact on the enforcement efforts of other administrative agencies reliant on ALJs. The Court's reasoning suggests that a large number of other agencies' administrative enforcement actions could be susceptible to the argument that they have common law analogues and seek the imposition of remedies that are punitive in nature, requiring a jury.

DWT continues to monitor developments in this area. Should you have any questions or concerns about these or any other developments, please contact a member of our financial services team.

[1] 492 U.S. 33 (1989)

[2] 481 U.S. 412 (1987)

[3] 137 S. Ct. 1625 (2017)