SEC Loses Home Court Advantage

by Daniel D. Hill

On May 18, 2022, the Fifth Circuit Court of Appeals, in a 2-1 decision, dealt a significant blow to the SEC’s internal adjudicatory or enforcement process. Jarkesy v. SEC, Case No. 20-61007 (5th Cir. May 18, 2022).

More specifically, the Jarkesy decision ruled, first, that the SEC’s in-house adjudication or administrative process violates the 7th Amendment’s right to a jury trial. Finding that an enforcement action brought by the SEC in the SEC’s own in-house administrative process is “akin to traditional actions at law to which the jury-trial attaches,” the Fifth Circuit concluded that persons subjected to such an enforcement action are entitled to a jury trial, which the SEC process does not afford. The in-house enforcement action is thus unconstitutional.

The Fifth Circuit, however, did not stop there. Its second ruling cut even deeper into the SEC’s internal administrative process. That second ruling found that Congress’ delegation of authority to the SEC for in-house enforcement actions is unconstitutional because that delegation of authority is legislative in nature, and did not come with “an intelligible principle by which the SEC would exercise the delegated power.” Congress’ delegation to the SEC, according to the Jarkesy majority, came with a “total absence of guidance” and is thus unconstitutional.

In strike 3 to the SEC’s internal enforcement process, the Fifth Circuit also found that the statutory removal restrictions protecting SEC administrative law judges renders the SEC’s ALJs unconstitutional. In more detail the Court explained, in essence, that the SEC’s ALJs “perform substantial executive functions” and, as a result, the President must be able to choose who holds those positions. Removal of the SEC’s ALJs, however, is strictly limited by “at least two layers of for-cause protection from removal,” which is unconstitutional. The SEC’s ALJs thus have no authority to rule on enforcement actions brought by the SEC before them.

As a result, the Jarkesy decision makes it much more difficult for the SEC to bring enforcement actions using its own internal processes. Instead, if the SEC wants to avoid distracting and protracting legal defenses, it will need to pursue its enforcement actions in Article III courts, instead of its own internal administrative law “courts.”

Utah Business Lawyer Daniel Hill

Daniel D. Hill