Advisors accused of serious wrongdoing by the SEC will always get to take their cases in front of a jury, following a ruling by the U.S. Supreme Court on Thursday.
The high court’s landmark 6-3 ruling in Securities and Exchange Commission v. Jarkesy strips the SEC of its ability to skip jury trials and take cases seeking civil penalties for fraud and other misdeeds before in-house tribunals known as administrative law judges, or ALJs. George Jarkesy, a former advisor and hedge manager who was accused by the SEC in 2013 of making misstatements about a pair of funds holding $24 million in client assets, argued that the system stripped him of his Seventh Amendment right to a jury trial.
A group of conservative justices, led by Chief Justice John Roberts, agreed on Thursday.
“A defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator,” Roberts wrote. “Rather than recognize that right, the dissent would permit Congress to concentrate the roles of prosecutor, judge, and jury in the hands of the Executive Branch. That is the very opposite of the separation of powers that the Constitution demands.”
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The decision also sends Jarkesy’s case back to a lower court for trial. In 2020, an SEC administrative law judge found that Jarkesy had violated various securities laws and ordered him and his advisory firm, Patriot28, to pay $300,000 in civil penalties and disgorge $686,000 in allegedly ill-gotten gains.
Jarkesy, now the host of a conservative radio talk show, responded with a legal campaign in federal courts questioning the SEC’s basic right to hear cases like his in-house. He succeeded in May 2022 before the Fifth Circuit Court of Appeals, which overturned the SEC’s decision to impose civil penalties.
In an official statement, Jarkesy said the decision marks “a great day for the Constitution, the legal process and the rule of law.”
Lawyer Michael McColloch, who argued Jarkesy’s case before the Supreme Court in November, said in a statement, “Now the entire federal government is forced to play by the same litigation rules as everyone else — in real courts before real judges, just as our Founders intended.”
Peggy Little, a senior litigation counsel at the New Civil Liberties Alliance who has represented clients in several cases challenging in-house judges, said defendants in SEC cases involving civil penalties could still choose to waive their right to a jury trial and end up before an administrative law judge. But she doubts many, if any, will.
Little noted that the SEC had greatly curtailed the number of cases it was taking before ALJs, even before Thursday’s ruling. The agency may still use its in-house tribunals for minor matters, such as improper advisor registrations.
“But if it’s a claim for fraud and or it imperils a defendant’s rights to life, liberty, reputation, property or any claims for money damages, I think they have to bring it in court,” Little said.
Philip Moustakis, a partner at Seward & Kissel, said he doesn’t think the ruling will defang the SEC. He said the agency has had success obtaining both settlements and judgments it has brought to the courts in the past. It will also be able to continue using its administration system to seek industry disbarments and other remedies short of punitive fines.
And since Thursday’s Supreme Court ruling explicitly applies to civil penalties, Moustakis said there’s still a chance the SEC could win disgorgement — or the repayment of ill-gotten gains to victims — through its administrative system.
“I don’t think this is a crippling blow by any stretch,” Moustakis said. “They will continue to pursue the cases they would have otherwise pursued in administrative proceedings in district court. That adds a layer of judicial review, which has rarely if ever created a hurdle to the SEC’s end goals in reaching a settlement.”
That’s not to say the SEC is escaping unscathed. Moustakis said there are some sorts of charges that can only be brought administratively. Those include “causing” violations — in which one person’s actions or negligence is alleged to have caused another’s misdeeds — and “failure to supervise,” or shortcomings in firms’ oversight duties. If the SEC is now barred from using its administrative processes to hand down civil penalties, it may not be able to impose penalties in causing and failure to supervise cases at all.
“So the SEC is losing a pair of important tools,” he said.
The SEC has long had the power to bar firms or individual advisors from the industry. But only with the adoption of the Dodd-Frank Act in 2010 — passed in response to the financial collapse two years earlier — did its administrative law judges gain broad powers to impose civil penalties.
Jarkesy’s case attacked that authority on several fronts. Besides arguing it violates the right to a jury trial, Jarkesy’s lawyers argued Congress didn’t have the right to delegate so much administrative power to the SEC in the first place and questioned the constitutionality of the system used to appoint administrative law judges.
Critics of the SEC have long contended its in-house judges are too close to the regulators who bring allegations against advisors and other financial professionals. Many argue the SEC gains a formidable “home-court advantage” through the cohabitation of its adjudication and enforcement functions.
Jarkesy’s case against the SEC comes amid a general erosion of the powers of the administrative state following former President Donald Trump’s appointment of three conservative justices to the high court. In May 2023, for instance, the Supreme Court handed down a decision rolling back the Environmental Protection Agency’s authority to enforce regulatory protections for wetlands.
A separate case involving an investment advisor went before the Supreme Court in November 2022 over questions of whether plaintiffs should be able to turn to federal courts to challenge ALJs’ constitutionality. That dispute was dismissed in June when the SEC dropped 42 pending enforcement cases after discovering its staff had mishandled internal memos.
