Fifth Circuit Holds SEC's In-House Forum Is Unconstitutional

• Published date: 30 May 2022
• Subject Matter: Corporate/Commercial Law, Consumer Protection, Corporate and Company Law, Securities, Dodd-Frank, Consumer Protection Act
• Law Firm: Jenner & Block
• Author: Mr Charles D. Riely, Gabriel K. Gillett and Cianan M. Lesley

When Congress passed the Dodd-Frank Act, it expanded the SEC's power to use its in-house administrative forum to bring enforcement actions. Supporters said this change promoted investor protection by giving the SEC a more efficient avenue in an expanded set of cases. Almost a decade after Dodd-Frank was passed, however, this benefit has not materialized. Instead, the SEC's in-house forum has been subject to repeated constitutional attacks and has been criticized for failing to serve as a fair forum to litigate cases to final judgment more quickly.

Most recently, a divided panel of the Fifth Circuit in Jarkesy v. Securities and Exchange Commission, No. 20-61007 (5th Cir. May 18, 2022), found that the use of in-house administrative law judges (ALJs) by the SEC is unconstitutional because it violates the Seventh Amendment's right to a jury trial, reflects an impermissible delegation of authority to the agency, and features adjudicators that are improperly insulated from removal. Each of these holdings is interesting in its own right and may provide fodder for other litigants seeking to cast doubt on the actions of ALJs used by the SEC and perhaps other federal agencies. This article describes the issues at play in the case and discusses how the continuing uncertainty of the constitutionality of the SEC's in-house forum may impact the agency going forward.

Constitutional Issues Raised by Jarkesy

In Jarkesy, an investment adviser and its principal (Petitioners) challenged the constitutionality of the SEC in-house forum. Agreeing with the challengers, the majority of the panel (Judges Elrod and Oldham) found three independent defects in the SEC's use of an ALJ to adjudicate Petitioners' case.

First, the Fifth Circuit held that the proceedings deprived the Petitioners of their right to a jury trial under the Seventh Amendment. The Court found that the SEC's enforcement action arose "at common law" under the Seventh Amendment. Jarkesy, slip op. at 9. Relying heavily on Tull v. United States, 481 U.S. 412, the Fifth Circuit explained that because the SEC sought civil penalties―a "common-law-like" legal remedy―the action was firmly within the common law. See Jarkesy, slip op. at 7. While the SEC ordered equitable remedies in conjunction with the civil penalties, the Court found that the civil penalty was sufficient to trigger the Seventh Amendment's protections. Jarkesy, slip op. at 10.

In so holding, the panel rejected the SEC's argument that it was vindicating...