The impact of the Supreme Court’s 6-3 decision in SEC v. Jarkesy, limiting the commission’s use of in-house judges, will likely have long-term consequences, with securities attorneys speculating that SEC settlement offers may increase and state regulators may take the reins on cases that would previously have been led by the federal regulator.
The Supreme Court case originated with George Jarkesy, a hedge fund manager and conservative radio talk show host. In 2013, the SEC charged Jarkesy with fraud, and the defendant lost in a decision before one of the commission’s administrative law judges (ALJs).
These in-house justices purportedly have specialized subject matter experience and help the commission and defendants avoid the expense and time of a jury trial. But critics claim it violates defendants' constitutional rights.
According to MarketCounsel CEO Brian Hamburger, the system's integrity was threatened by its very setup.
“It’s hard to have credibility among registrants when judges are drawing a paycheck from the same employer as one side of the case,” he said.
In 2022, the Fifth Circuit Court of Appeals sided with Jarkesy, agreeing that the SECs use of in-house judges was unconstitutional and deprived Jarkesy of his right to a jury trial in federal court.
The Supreme Court heard the appeal last fall, with representatives for the Biden administration arguing that jury right doesn’t apply when Congress has authorized administrative agencies, like the SEC, to determine so-called “public rights,” according to Bloomberg.
But the Court affirmed the Fifth Circuit’s ruling last week, with the six Republican justices agreeing that the SEC’s use of in-house judges violated the Constitution. In a dissent, Justice Sonia Sotomayor argued that numerous other agencies, including the Federal Trade Commission, Department of Agriculture and Environmental Protection Agency, also use such judges and warned that the decision threatened to release “chaos” across the government.
Hamburger didn’t think the decision would have a chilling effect on cases the SEC would bring but noted the SEC’s win rate in front of the commission's administrative law judges was “enormous.” He hoped the commission would opt for more reasonable settlement offers now that cases could be tried in federal court.
“There’s going to be a new weighing of the cost-benefit of settling these matters, and the weight has tipped in favor of registrants and advisors,” Hamburger said. “There has to be a consideration made that having this matter heard in front of a judge that’s not an ALJ is going to change the calculus for their likelihood to succeed.”
Weakening the regulatory authority of administrative judges has long been a goal for conservative activists and watchdogs, and with changes at the Supreme Court and federal appeals court level, the writing was on the wall for the SEC, according to Max Schatzow, an attorney and partner with RIA Lawyers.
“If you look at the timeline of Jarkesy, the appointment of new judges to the Court, and the conservative reaching of the federal judiciary by and large, you’ll see the staff was keeping tabs on this and decided ‘we have to stop bringing cases to the ALJs,'” he said.
The SEC has been moving such cases away from administrative judges during the past five to seven years, particularly those involving civil penalties. Therefore, Schatzow expected the immediate impact on the commission’s enforcement actions to be minimal, since cases like Jarkesy’s are already likely to go to federal court if they aren't settled.
Schatzow also didn’t expect much change in how the commission and defendants approach settlements, arguing that if an accused registrant believed in their case, they were likely going to defend themselves whether they wound up in a jury trial or before an in-house judge.
However, Schatzow found it unclear how the Court’s decision would impact previous rulings; unlike the Court’s ruling last week overturning the 1974 Chevron Doctrine that further weakened federal agencies, the Court didn’t clarify whether its ruling in Jarkesy was retroactive.
Schatzow said many cases would be time-barred, but there were some in recent years that resulted in civil penalities that might be revisited.
“A case like that would be ripe for potential challenge,” he said.
In the meantime, if both the defendant and the commission agree, a case still may move forward with administrative judges, according to Ben Edwards, a professor at the William S. Boyd School of Law at the University of Nevada, Las Vegas.
Both parties may prefer the speed the administrative judge process affords, compared to a jury trial, which can stretch out for years.
But Congress should consider giving the SEC more resources if the commission will have to pursue more cases in costly federal court proceedings, Edwards said.
“If you want the SEC to deter fraud and to hold people accountable when they do commit fraud, we need to give them the resources to do it,” he said. “Because the last thing we want is the financial markets filled with fraud.”
Some legal observers say state securities regulators may pick up cases in the wake of the ruling.
“It’s possible the SEC might come across some cases where it might make more sense to coordinate with state securities regulators,” said Andrew Jennings, an associate professor at Emory University’s School of Law. “I’d expect that would develop organically between regional SEC divisions and their state counterparts.”
Like Jennings, Edwards suggested the SEC might start working with with state administrative agencies and hand off some cases that could be pursued under state jurisdiction. Though the Court’s opinion applies to the SEC’s process of using in-house judges, the Court’s ruling that these proceedings violated the Seventh Amendment right to a jury trial many not apply in the same way to states. Some state securities regulators (though not all) have their own versions of administrative proceedings.
“What state capability is varies dramatically by state,” he said. “It would not surprise me if you see some shifts there.”
Jennings agreed, noting that defendants don’t always have the right to a civil jury trial in state courts; many small claims court decisions throughout the country are routinely decided by judges, for example.
But while the right may not explicitly exist at the state level, as state courts look to the Jarkesy precedent for inspiration, the legal avenues for securities regulators on the state level may narrow as well.
“There could be, at the state level, many Jarkesy-esque suits, where as a matter of state law…they may say ‘no, the state entitlement to a civil jury is analogous to the Seventh Amendment,’” he said.
The Court’s decision limits the use of administrative law judges in trials with potential civil penalties, so situations in which the commission seeks to bar an alleged bad actor from the industry aren’t likely to be affected for now.
But future litigation could build on Jarkesy, with Jennings speculating a broker/dealer may protest the commission’s ability to levy any kind of administrative penalty, including a bar.
“That power is still there,” he said. “Whether that challenge would be successful, I don’t know.”
Though the Court’s decision pertains to the SEC’s use of in-house judges, as Justice Sotomayor intimated, it could have knock-on effects for numerous other governmental agencies who employ similar operations. The decision could also impact FINRA’s operations, as the agency is currently locked in its own court battle with the registrant Alpine Securities in D.C. appeals court.
The case threatens the legitimacy of FINRA’s own disciplinary proceedings, questioning whether its use of “hearing officers” to head arbitration panels ruling on cases are essentially judges and therefore unconstitutional. Edwards said the Court's ruling in Jarkesy is "not a good sign" for regulators.
"Their skepticism about agency enforcement through ALJs may also carry over to self-regulatory organization enforcement through their own in-house processes," he said.
