Supreme Court Rules SEC In-House Judge Process Is Unconstitutional

Decision upholds defendants’ rights to a jury trial when civil penalties are imposed.

The Supreme Court ruled in favor of George Jarkesy in the case Securities and Exchange Commission v. Jarkesy on Thursday.

The court ruled, in a 6-3 decision, that “when the SEC seeks civil penalties against a defendant for securities fraud, the Seventh Amendment entitles the defendant to a jury trial.” The court decision continues that “while courts of equity could order a defendant to return unjustly obtained funds, only courts of law issued monetary penalties to punish culpable individuals.”

Jarkesy was a hedge fund manager who was charged by the SEC with violating securities laws for misrepresenting two private funds he managed. Jarkesy was fined almost $1 million in disgorgement and penalties. Jarkesy challenged the SEC’s in-house administrative law judge process, under which he was fined, and argued that it was unconstitutional under the Seventh Amendment to the Constitution, which requires a jury trial and an Article III Court for civil cases.

Jay Dubow, a partner with the Troutman Pepper law firm and a former enforcement attorney with the SEC, says that based on the way the court wrote the decision, it is limited to monetary penalties in civil cases and “one can argue its limited to civil fraud cases.”

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“The SEC could still seek disgorgement or equitable relief,” such as removing a board member, Dubow says, through the commission’s in-house judges.

Disgorgement is a fine that offsets unjust gains and is normally returned to impacted investors where possible, Dubow explains. Cases that seek disgorgement only “could still be brought administratively,” Dubow argues, though the SEC usually also seeks civil penalties as well but “if they seek both they would have to go to federal court.”

How this case affects other agencies is “really the big question here,” Dubow says, and this case certainly “invites challenges to other ALJs.” He names the FTC and CFTC as agencies that are likely to face new legal challenges that cite this case.

Other ALJs that do not issue civil penalties and adjudicate “public rights,” likely would also be untouched by this decision. Public rights, according to the decision, include disputes over benefits, immigration and customs, public lands, and relations with Native American tribes. During oral arguments in November, Justice Neil Gorsuch indicated that most ALJs work for the Social Security Administration and normally adjudicate disputes over benefits and so are not at issue in this case.

When it comes to the SEC’s ability to bring cases, “I don’t think it’s really going to impact it a whole lot,” Dubow says. “They have cut back on ALJs for a number of years” in favor of taking cases to court.” If the court had ruled in the SEC’s favor “I think it would have had a more profound effect,” because the SEC would likely pursue more cases administratively after the process was affirmed by the court.