Jarkesy Limits Power of the SEC to Rely on In-House Adjudicators When Pursuing Penalties for Fraud

At a Glance

• Previously, the SEC could elect to litigate fraud cases before its administrative law judges, where it had “home court” advantage, and who often have considerable subject-matter expertise, but now it must bring such cases in a U.S. federal court.
• Litigating more frequently in federal court will require greater resources, potentially diverting resources from investigating potential new cases, and will entail greater litigation risk overall.
• Because of the higher evidentiary standards in federal court, the Jarkesy ruling is a win for defendants in SEC enforcement actions. Jarkesy presents a basis for challenging the SEC’s election of ALJ proceedings in other types of cases. Litigation of such issues will no doubt persist for many more years. 

The U.S. Supreme Court limited the power of the Securities and Exchange Commission (SEC) to enforce civil penalties via in-house tribunals in its decision in SEC v. Jarkesy, released on June 27, 2024. In its decision, authored by Chief Justice Roberts, the Court ruled that if the SEC pursues monetary penalties in a securities fraud case, it cannot do so before one of its in-house administrative law judges (ALJs) — it must do so in a federal court where there is a right to a jury trial.

The case specifically deals with the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940. The SEC typically pursues civil monetary penalties against persons and entities subject to regulation accused of violating these statutes, although it may also seek other nonmonetary remedies, such as orders of disgorgement, injunctive relief and industry bars. The Court based its decision on both (1) the purpose of civil penalties, which, by seeking to punish or deter wrongdoing, goes beyond merely restoring the status quo and (2) the fact that the SEC’s antifraud provisions mirror common-law frauds that would entitle the defendant to a jury trial under the Seventh Amendment. 

Relying heavily on its previous decision in Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989), the Court also determined that the “public rights” doctrine did not apply here. That doctrine holds that certain public rights, such as tribal issues and foreign commerce, can be properly adjudicated outside of Article III courts because they historically fall within the powers of the legislative and executive branches. The Court held that assessing civil monetary penalties for securities fraud violations were private rights that cannot be removed from Article III courts. Jarkesy essentially returned the SEC to a pre-Dodd-Frank scheme, requiring that it pursue penalties in front of an Article III federal court judge, where the regulated entity would maintain the right to a trial by jury.

The Court remanded the matter to the Fifth Circuit for further proceedings, dodging other administrative law issues including the nondelegation doctrine and for-cause removal. 

What Jarkesy Means for SEC Enforcement Actions

Previously, the SEC could elect to litigate fraud cases before its ALJs, where it had “home court” advantage, and who often have considerable subject-matter expertise, but now it must bring such cases in a U.S. federal court.

The decision does not make clear whether SEC antifraud enforcement actions that sought only equitable remedies would also have to be heard by federal courts. Even if those types of remedies could still be adjudicated by ALJs, Jarkesy could force the SEC to pursue civil penalties and other injunctive relief from a federal court at the outset, and then potentially seek “follow on” relief from an ALJ pursuant to the federal court’s orders. Overall, after Jarkesy, the SEC is likely to utilize its ALJs far less frequently, as many of its cases involve fraud, and civil penalties are commonly sought for their supposed deterrent effect. Conversely, litigating more frequently in federal court will require greater resources, potentially diverting resources from investigating potential new cases, and will entail greater litigation risk overall (as exemplified by the recent disastrous SEC v. DEBT Box case, in which a Utah court sanctioned the SEC for lying to the court in connection with its application for emergency relief). 

As highlighted in the concurrence, authored by Justice Gorsuch, trials in federal courts will also ensure that defendants receive the additional protections of the Federal Rules of Civil Procedure and Federal Rules of Evidence. This distinction is important because agency hearings generally admit hearsay evidence as long as it is relevant and material to the matter; of course, the Federal Rules of Evidence do not generally permit hearsay evidence barring one of the recognized exceptions. Generally, as well, the SEC’s Rules of Practice before its ALJs, like other administrative agency proceedings, do not typically allow depositions as part of more limited pretrial discovery, compared with the Federal Rules. In this way, Jarkesy will make it more difficult for the SEC, which will have to endure a more extensive, time-consuming litigation process, to obtain civil penalties. 

Because of the higher evidentiary standards in federal court, the Jarkesy ruling is a win for defendants in SEC enforcement actions as well as any persons or entities that are on the receiving end of SEC “Wells Notice” warnings of potential enforcement action. Jarkesy presents a basis for challenging the SEC’s election of ALJ proceedings in other types of cases. Litigation of such issues will no doubt persist for many more years.