The Supreme Court limits the SEC’s authority to unilaterally enforce fraud laws

The Supreme Court on Thursday limited the Securities and Exchange Commission’s authority to enforce security fraud laws, agreeing with a hedge fund manager and former conservative radio show host who said he was entitled to a jury trial rather than an internal review by agencies.

The decision could have huge implications for the SEC and other agencies, requiring them to prosecute violations in federal court rather than through more streamlined internal review. That could make it harder to prosecute fraud and protect investors while also increasing the backlog in federal courts.

Chief Justice John Roberts wrote the decision by a 6-3 majority, with three of the court’s liberals dissenting.

The Supreme Court has declined to address more existential challenges to the agency’s enforcement structure, including claims that it could seriously undermine the government’s ability to use its internal administrative law judges or protect them from the president’s political whims.

“A defendant facing a fraud lawsuit has the right to be tried by a jury of his peers before a neutral arbitrator,” Roberts wrote. “Rather than recognizing that right,” his dissenting colleagues wrote, “would allow Congress to concentrate the roles of prosecutor, judge, and jury in the hands of the executive branch.”

“This is the complete opposite of the separation of powers required by the Constitution,” he wrote.

Sotomayor reads the dissent on the bench

In a dissent by Justice Sonia Sotomayor, signed by two other liberals on the court, Thursday’s decision was called a “power grab” that “undermines long-standing precedent and established practice of equal partners in our tripartite system of government.”

She said the “serious consequences of the majority’s insistence that the government’s civil penalty rights now be heard by a jury in federal court” should be expected.

“Today’s ruling is part of a troubling trend: When it comes to the separation of powers, this Court is telling the American public and its affiliates that it knows best,” Sotomayor wrote, later adding that the decision about whether to use the domestic agency adjudication system is a policy decision that Congress should make.

“Make no mistake: today’s decision is a power grab,” she wrote. “It imposes artificial constraints on what modern, responsive governance must look like.”

However, the court’s decision was much narrower than it could have been. The Louisiana appellate court, which also ruled against the SEC, adopted a broader series of arguments that could have hampered enforcement by several agencies. Rather than address these issues, Roberts focused entirely on the question of whether the Seventh Amendment requires jury trials for the types of actions at issue.

George Jarkesy, the hedge fund manager at the center of the dispute, praised the court’s ruling, saying that “the implications of this case are much bigger than one person.”

“After a decade of egregious misconduct and blatantly unconstitutional political attacks by the SEC and its internal court, the Supreme Court of the United States ruled today that the Constitution still matters,” he said in a statement.

Federal government agency in the crosshairs

The case, one of several at the time challenging the authority of federal agencies, occurred in 2013 when the SEC brought a securities fraud enforcement action against Jarkesy, who had formed two hedge funds with assets worth about $24 million dollars and attracted over 100 investors.

The agency accused Jarkesy of inflating the value of assets in order to charge higher fees. An administrative law judge – an in-house agency official who adjudicates such claims – upheld the charges and ordered Jarkesy to pay a $300,000 civil penalty and restitution of nearly $685,000 in “ill-gotten gains.”

Jarkesy challenged not only the decision but also the process used to reach it. He argued that the internal procedure violated his 7th Amendment right to a jury trial. He also argued that the manner in which the agency’s administrative law judges are appointed violates other provisions of the Constitution because the president cannot remove them in most cases.

Such safeguards were put in place in the 1940s to shield agency judges from politics and criticism that the proceedings were biased in favor of the agencies they worked for. SEC administrative judges can be removed from office only for “cause” by SEC commissioners, who can also be removed for cause.

The SEC is composed of five members appointed by the president and confirmed by the Senate. The commission can enforce various federal laws in two ways. May initiate administrative enforcement proceedings for civil penalties or may bring civil actions in federal court.

The 5th U.S. Circuit Court of Appeals upheld Jarkesy on three constitutional claims. The court found that some SEC proceedings deprived individuals of the right to a jury trial. It found that Congress improperly delegated legislative authority to the SEC by giving it the authority to choose internal administrative recourse rather than federal court. It also found that the manner in which administrative law judges were protected from removal violated constitutional principles of presidential authority.

Other agencies use similar in-house adjudicators to review fraud claims, including the Department of Labor and the Social Security Administration.

The SEC case is one of several before the Supreme Court this year that involve an attempt to undermine the authority of federal agencies. Two cases heard in mid-January challenged the agency’s ability to interpret unclear rules when setting regulations. Another concerned the funding mechanism for the Consumer Financial Protection Bureau, an agency created after the 2008 financial crisis.

On May 16, a 7-2 majority upheld this funding structure in an opinion written by Justice Clarence Thomas that represented a significant victory for the Biden administration.

This story has been updated with additional information.

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