The impact of the decision 6-3 of the Supreme Court in SEC v. Jarkesi, Limiting the panel's use of in-house judges is likely to have long-term ramifications, with securities lawyers speculating that SEC settlement offers could increase and state regulators could rein in cases that previously would have directed by the federal regulator.

The Supreme Court case was started by George Jarkesy, a hedge fund manager and conservative radio talk show host. In 2013, the SEC charged Jarkesi with fraud, and the defendant lost a decision before one of the commission's administrative law judges (ALJs).

These in-house judges are supposed to have specialized experience in the case and help the commission and defendants avoid the expense and time of a jury trial. But critics claim it violates the defendants' constitutional rights.

According to MarketCounsel CEO Brian Hamburger, the integrity of the system was threatened by its very configuration.

“It's hard to have credibility among registrants when the judges are getting paid by the same employer as one side of the case,” he said.

In 2022, the Fifth Circuit Court of Appeals sided with Jarkesy, agreeing that the SEC's use of in-house judges was unconstitutional and deprived Jarkesy of his right to a jury trial in federal court .

The Supreme Court heard the appeal last fall, with representatives of the Biden administration arguing that the right to a jury does not apply when Congress has authorized administrative agencies, such as the SEC, to determine so-called “public rights,” according to Bloomberg.

But the Court affirmed the Fifth Circuit's decision last week, with six Republican justices agreeing that the SEC's use of in-house judges violated the Constitution. In a dissent, Justice Sonia Sotomayor argued that many other agencies, including the Federal Trade Commission, the Department of Agriculture and the Environmental Protection Agency, also use such judges, and warned that the decision threatened to unleash “chaos” across the government. .

Hamburger didn't think the ruling would have a ripple effect on cases the SEC would bring, but noted that the SEC's winning percentage before the commission's administrative law judges was “huge.” He hoped the commission would choose more reasonable settlement offers now that the cases could be tried in federal court.

“There will be a new weighing of the cost and benefit of resolving these issues, and the weight has tipped in favor of enrollees and counselors,” Hamburger said. “It should be noted that hearing this case before a judge who is not an ALJ will change the calculus of their likelihood of success.”

Weakening the regulatory authority of administrative judges has long been a goal of conservative activists and watchdogs, and with changes at the Supreme Court and federal appeals court levels, the writing was on the wall for the SEC, according to Max Schatzow, an attorney and partner. with RIA lawyers.

“If you look at Jarkesy's timeline, the appointment of new judges to the Court and the conservative reach of the federal judiciary in general, you'll see that the staff was looking at this and decided 'we've got to stop bringing cases to ALJs,'” he said. he.

The SEC has been moving such cases away from administrative judges over the past five to seven years, especially those involving civil penalties. Therefore, Schatzow expected the immediate impact on the commission's enforcement actions to be minimal, since cases like Jarkesy's are already likely to go to federal court if not resolved.

Schatzow also didn't expect much change in how the commission and defendants approach settlements, arguing that if an accused registrant believed their case, they would be protected if they ended up in a jury trial or before an in-house judge. .

However, Schatzow found it unclear how the Court's decision would affect previous decisions; unlike the Court's decision last week overturning the 1974 Chevron Doctrine that further weakened federal agencies, the Court did not clarify whether its decision was valid Jarkes it was retroactive.

Schatzow said many cases would be statute-barred, but there have been some in recent years that resulted in civil penalties that could be reviewed.

“Such a case would be ripe for potential challenge,” he said.

Meanwhile, if the defendant and the commission agree, a case can move forward with administrative judges, according to Ben Edwards, a professor at the William S. Boyd School of Law at the University of Nevada, Las Vegas.

Both parties may prefer the speed that the administrative judge process offers, as opposed to a jury trial, which can take years.

But Congress should consider giving the SEC more resources if the commission has to pursue more cases in costly federal court proceedings, Edwards said.

“If you want the SEC to deter fraud and hold people accountable when they commit fraud, we have to give them the resources to do it,” he said. “Because the last thing we want are financial markets full of fraud.”

Some legal observers say state securities regulators may take issue after the ruling.

“It's possible that the SEC may run into some cases where it might make more sense to coordinate with state securities regulators,” said Andrew Jennings, an associate professor at Emory University School of Law. “I would expect this to develop organically between the SEC regional divisions and their state counterparts.”

Like Jennings, Edwards suggested that the SEC could begin working with state administrative agencies and file some cases that could be prosecuted under state jurisdiction. Although the Court's opinion applies to the SEC's process of using in-house judges, the Court's ruling that these procedures violated the Seventh Amendment right to a jury trial, many do not apply in the same way to the states. Some state securities regulators (though not all) have their own versions of administrative procedures.

“What the state's capability is varies dramatically by state,” he said. “It wouldn't surprise me if you see some changes there.”

Jennings agreed, noting that defendants are not always entitled to a civil jury trial in state courts; For example, many small claims court decisions across the country are routinely decided by judges.

But while the right may not exist explicitly at the state level, as state courts look at it Jarkes precedent for inspiration, legal avenues for state-level securities regulators may also narrow.

“At the state level, there can be many Jarkes– lawsuits, where as a matter of state law … they can say 'no, the state's right to a civil jury is analogous to the Seventh Amendment,' he said.

The Court's decision limits the use of administrative law judges in trials with potential civil penalties, so situations in which the commission seeks to bar a suspected bad actor from the industry are not likely to be affected for now.

But future litigation may continue Jarkes, with Jennings speculating a broker/dealer could protest the commission's ability to impose any type of administrative penalty, including a bar.

“That power is still there,” he said. “Whether that challenge would be successful, I don't know.”

Although the Court's ruling addresses the SEC's use of in-house judges, as Justice Sotomayor said, it could have damaging effects on many other government agencies that use similar operations. The ruling could also affect FINRA's operations, as the agency is currently mired in its own court battle with registrar Alpine Securities in the DC appeals court.

The case threatens the legitimacy of FINRA's own disciplinary proceedings, calling into question whether its use of “hearing officers” to head arbitration panels that rule on cases are essentially judges and thus unconstitutional. Edwards said that the Court's decision in Jarkes not “a good sign” for regulators.

“Their skepticism about agency enforcement through ALJs may also carry over to self-regulatory organizations' enforcement through their own internal processes,” he said.