SEC Grapples with Jarkesy Case as Meta Lawsuit Waits in the Wings

The legal world witnessed a riveting face-off last week as the Supreme Court delved into the intricacies of SEC v. Jarkesy. The case, stemming from a divided opinion by the Fifth Circuit in May 2022, challenges the constitutionality of in-house adjudicative processes used by administrative law judges – common fixtures in various administrative agencies.

The Supreme Court’s decision to grant certiorari in June set the stage for a two-hour oral argument battle. Notably, it became apparent that some of the justices weren’t exactly in the SEC’s corner, hinting at a dramatic overhaul of how federal agencies are permitted to bring what were once considered run-of-the-mill enforcement actions.

While the ruling is pending, let’s unravel the arguments, consider the implications for the SEC – and federal agencies in general – and explore potential preemptive actions by Congress or agencies.

The Jarkesy Journey Begins

This case arises from a rather standard enforcement action by the SEC. George Jarkesy opened a hedge fund, raised more than $20 million in assets from over 100 investors, and then allegedly committed a variety of misdeeds. An SEC administrative law judge ordered Jarkesy and others to pay a penalty and disgorge ill-gotten gains and barred him from a variety of positions. He appealed to the commission itself, as permitted by statute, which ruled against him.

But then, Jarkesy appealed to the Fifth Circuit, arguing that the whole process violated his constitutional rights. In a sharp 2-1 decision, the appeals court judges agreed with Jarkesy.

The Fifth Circuit’s Verdict: Unpacking the Drama

Their first reason was rooted squarely in the Seventh Amendment, which preserves the right to a jury in “suits at common law,” a phrase found to encompass all lawsuits in which a party’s legal rights were to be determined.

ALJs in enforcement actions hold bench trials that do not take place in front of a jury. However, the Supreme Court unanimously and explicitly decided in 1977, in Atlas Roofing v. Occupational Safety and Health Review Commission, that Congress has the power to give an executive agency authority to adjudicate violations of agency regulations without violating the Seventh Amendment, upholding, ironically, a decision from the Fifth Circuit.

“It could not have been clearer that what they were saying [in Atlas Roofing] was that the Seventh Amendment was no bar to Congress making a decision that certain kinds of claims were best adjudicated in administrative agencies,” Justice Elena Kagan said during oral arguments on Jarkesy last week. “Nobody has had the chutzpah ― to quote my people ― to bring it up since Atlas Roofing!” Justice Gorsuch, on the other hand, stated that “The right to trial by jury, whether it’s criminal or civil is a very important foundational freedom in American society and a check on all branches of government.”

The second reason for supporting Jarkesy was rooted in the Take Care Clause of Article II, which requires the president to “take care” that the law is faithfully executed. to ensure that the law is faithfully executed, the president must retain the power to appoint and remove officers. SEC ALJs may only be removed for “good cause,” which overly constrains the president’s power, the Fifth Circuit ruled.

The third reason derived from a broad application of the nondelegation doctrine. Congress is permitted to delegate its legislative authority to administrative agencies because of the complexity of the matters that agencies regulate. Congress issues a broad directive, with an “intelligible principle” to which the agency is directed to conform. As the Supreme Court explained in Mistretta v. United States, Congress simply does not have the time or expertise to promulgate every rule necessary in “an increasingly complex society, replete with ever changing and more technical problems.” But the Fifth Circuit found that no intelligible principle here allowed the SEC to decide which defendants face adjudication before an ALJ and which defendants face review by a federal district court.

“The government can deprive you of your property, your money, substantial sums,” Justice Brett M. Kavanaugh said during arguments on Jarkesy, “in a tribunal that is at least perceived as not being impartial in the sense that it’s an in-house executive agency where the commissioners start the enforcement process, oversee the enforcers and then appoint the adjudicators and review the adjudication. That doesn’t seem like a neutral process.”

Navigating the Legal Maze Ahead

If the Fifth Circuit decision is upheld, the role of ALJs for the SEC will be drastically curtailed, if not unconstitutional. Power will also shift from the executive branch to the federal courts. Congress, unfortunately, is unlikely to act, given its partisan gridlock.

On the same day that oral arguments were held in Jarkesy, Meta filed a suit against the FTC in the U.S. District Court for Washington, D.C., making a strikingly similar argument as Jarkesy but with respect to  a different statute and different agency. If a decision in that case goes up on appeal, and the DC Circuit ends up disagreeing with the Fifth Circuit, the Supreme Court may choose to step in and address the issue of administrative courts  more broadly and the various interpretations of the Atlas Roofing case. If agencies cannot point to legislative authority for their actions, the nondelegation doctrine may come into play to dramatically constrain their authority..

Perhaps there is a middle ground that could provide a solution. As Professor Jonathan Adler has written, “It would be rather easy for Congress to create a presumptive right to remove agency enforcement actions from agency adjudications to federal court provided certain conditions are met (e.g. the agency is seeking certain sorts of penalties).” The agencies themselves could potentially do this with their own rule-making authority. However, a multitude of problems could result: Federal courts are already overworked and understaffed, and regulatory agencies don’t have the staff necessary to bring enforcement actions to full jury trials in these courts. Regardless, the issue before the Supreme Court now may be much broader than just agency authority. As Eric Orts pointed out just a few months ago, the court doesn’t need an excuse to weaken the SEC any more than it already has.

This post comes to us from John Livingstone and Anat Alon-Beck at Case Western Reserve School of Law.