Federal Court Calls Unconstitutional The U.S. Securities & Exchange Commission's In-House Administrative Proceedings For Securities Fraud Cases

• Published date: 13 July 2022
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Securities
• Law Firm: Miller, Canfield, Paddock and Stone P.L.C.
• Author: Mr Matthew Allen

Key Takeaways

• The U.S. Supreme Court is poised to hear cases that may curtail the administrative powers of the SEC
• These rulings may portend greater limits on federal administrative agencies generally

In Jarkesy v. Securities and Exchange Commission, the U.S. Court of Appeals for the Fifth Circuit held the SEC violates the constitution when it brings civil securities fraud charges before its own Administrative Law Judges (ALJs). The Fifth Circuit decision will almost certainly be appealed to the U.S. Supreme Court. This seems especially likely since the Supreme Court recently agreed to decide whether a respondent in a pending SEC administrative case may sue the SEC in federal district court to challenge the constitutionality of the restrictions on removal of SEC ALJs. See Securities and Exchange Commission v Cochran, No. 21-1239. The Cochran appeal, and the likely appeal of Jarkesy, set up the prospect that the Supreme Court may curtail the SEC's administrative powers, and the powers of federal administrative agencies generally.

Petitioner in Jarkesy hired an investment adviser to help run two hedge funds. The SEC investigated the funds and charged Jarkesy and others with fraud under the Securities Exchange Act and the Investment Advisers Act, alleging they made misrepresentations to investors. The 2010 Dodd Frank Wall Street Reform and Consumer Protection Act gave the SEC the option to pursue civil penalties in federal court before judges appointed under Article III of the U.S. Constitution, or in SEC administrative proceedings decided by ALJs selected by the SEC.¹ In Jarkesy, the SEC exercised its option to bring an administrative action for fraud before the SEC's own ALJ. The ALJ found that Jarkesy and others had committed securities fraud, issued civil monetary penalties and ordered disgorgement of ill-gotten gains. The Commission affirmed the ALJ's ruling, and rejected Jarkesy's arguments that the SEC administrative proceeding was unconstitutional. Jarkesy asked the Fifth Circuit to review the SEC's decision. The Fifth Circuit found, in a 2-1 decision, that the SEC's in-house adjudication of securities fraud cases was unconstitutional on three grounds:

1. The proceedings violated Jarkesy's Seventh Amendment right to a jury trial;
2. Congress unconstitutionally delegated legislative power to the SEC in violation of Article I of the Constitution, and
3. The statutory restrictions on removal of ALJs and the SEC Commissioners that hire them violated...