(Bloomberg) — The U.S. Supreme Court curbed the Securities and Exchange Commission's ability to bring complaints before domestic judges, saying defendants have a constitutional right to present their case to a federal jury when the agency requires financial penalties.
6-3 DECISION can reduce commission leverage for issuing multi-dollar payouts. It deals a blow to an administrative system the SEC once used to adjudicate more than 100 cases a year before scaling back amid legal challenges.
The decision could ripple across the government, potentially affecting the Federal Trade Commission, the Department of Agriculture and the Environmental Protection Agency. A Justice Department lawyer said during arguments that more than two dozen agencies now impose penalties through administrative procedures and that only some of those agencies have the ability to go to federal court.
Dissenting Justice Sonia Sotomayor said the ruling will cause “chaos” across the government.
The dispute is part of a Supreme Court term that is likely to have far-reaching implications for federal regulators. The justices are also considering whether to overturn a precedent that gives agencies leeway when interpreting vague congressional commands. The court's conservative majority has been broadly skeptical of what it sees as overreach by regulatory agencies.
The majority said that “the anti-fraud provisions of the SEC replicate common-law fraud” and that it was “well established” that those types of claims must be heard by a jury.
“A defendant facing a fraud claim has the right to be tried by a jury of his peers before a neutral judge,” Chief Justice John Roberts wrote for the majority. “Instead of recognizing this right, dissent would allow Congress to concentrate the roles of prosecutor, judge, and jury in the hands of the Executive Branch. This is the complete opposite of the separation of powers required by the Constitution”.
John Roberts, Chief Justice of the US Supreme Court
Roberts was joined by Justices Clarence Thomas, Samuel Alito, Neil Gorsuch, Brett Kavanaugh and Amy Coney Barrett.
Sotomayor listed 19 other agencies that also impose civil penalties through administrative proceedings. She said some agencies, including the Occupational Safety and Health Review Commission and the Federal Energy Regulatory Commission, currently lack the legal authority to go to court to seek civil penalties.
“For those and countless other agencies, all most can say is hard luck; get a new statute from Congress,” Sotomayor wrote in an opinion joined by Justices Elena Kagan and Ketanji Brown Jackson.
The latest decision is a victory for George Jarkesy, a former hedge fund manager and conservative radio host. The SEC charged Jarkes in 2013 with misleading investors about who served as the principal broker and auditor of his funds and about their investment strategies and holdings.
“The consequences of this case are much bigger than one person,” Jarkesi said in an emailed statement. “After a decade of gross misconduct and outright unconstitutional political attacks by the SEC and its own domestic court, today the United States Supreme Court ruled that the Constitution still matters.”
Order of the SEC
An administrative law judge found that Jarkes had committed securities fraud, and the SEC ultimately ordered him to pay almost $1 million. The high court decision annuls this order.
The Biden administration argued unsuccessfully that the SEC's complaints did not fall within the Seventh Amendment to the Constitution and its right to a jury trial. This provision by its terms applies to “common law” actions, which are usually between private parties.
The administration pointed to a 1977 Supreme Court decision that said Congress could create “public rights” aimed at protecting the common good and empower an agency to handle lawsuits.
Jarkes and his allies, including Elon Musk and Mark Cuban, said the SEC process is riddled with unfairness. Defendants have fewer rights to receive evidence in administrative hearings than in federal court, and SEC attorneys may rely on third-party “hearsay” testimony. Complaints go to the same SEC commissioners who approved the complaint in the first place.
Impact on industry
The decision could have a significant effect on how brokers, investment advisers and others subject to SEC rules can resolve cases. Many enforcement proceedings are resolved through the administrative process, which allows parties to submit enforcement orders and agreements at the same time.
The SEC may want to change its language in future administrative cases that explicitly require defendants to waive their rights to jury trials, said Rebecca Fike, a partner at the Dallas law firm Vinson & Elkins and a former senior counsel in the SEC's enforcement division.
If the regulator sees the decision as requiring even greater caution in the use of administrative judges, more cases could be settled in court, Fike said. That brings greater uncertainty for the SEC and defendants because it opens the door to a judge who disagrees with the deals, she said.
“There's something about court filings that most corporate defendants want to stay away from,” Fike said.
The high court's decision also raises the question of what constitutes fraud specifically in the securities context, said David Fredrickson, senior counsel at Covington & Burling and a former senior SEC attorney. Many cases that have challenged the agency's use of administrative proceedings have involved allegations of fraud, assuming the allegations are similar to common law fraud, he said.
“But Congress also authorized the SEC and possibly other agencies to determine things that are fraudulent,” Fredrickson said.
It's unclear whether claims of fraud that, for example, involve violations of SEC advertising rules or a broker's failure to provide confirmation of a sale can still go through the administrative process, he said.
The case is Securities and Exchange Commission v. Jarkesy, 22-859.