In a major blow to the Securities and Exchange Commission (SEC), the Supreme Court ruled in SEC v. Jarkesy that defendants against whom the SEC seeks civil penalties for securities fraud are entitled to jury trials under the Seventh Amendment, rather than adjudication through the SEC’s “in-house” administrative law judges. While only time will tell just how impactful the Jarkesy decision will be, this ruling has the potential to dramatically reshape the SEC’s enforcement efforts as we know them today.
Following the Great Recession in 2008, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dobb-Frank), which authorized the SEC to impose civil penalties on defendants through in-house proceedings before administrative law judges or even SEC Commissioners themselves. With this built-in advantage, the SEC’s “win-rate,” as well as its ability to force defendants into unfavorable settlements, rose considerably. In essence, the SEC was authorized to serve as “judge,” “jury,” and “executioner.” If you are the target of an SEC civil action, you should consult an experienced SEC Defense Attorney, like the ones at Malecki Law.
The Jarkesy decision stripped the SEC of this “multi-role” position and relegated the SEC’s civil actions back into federal court, where the SEC was forced to fight its battles for much of its history. In or around 2010, the SEC began investigating Geroge Jarkesy, Jr. (Jarkesy) and his firm, Patriot28, LLC (Patriot28), for suspected securities fraud in connection to two investment funds that Jarkesy managed. The SEC’s enforcement action alleged that Jarkesy and Patriot28 defrauded investors through various misrepresentations and omissions. The case was initially adjudicated by an administrative law judge who submitted an initial decision in 2014. In 2020, the SEC issued its final order against Jarkesy and Patriot28, levying a $300,000 civil penalty against the defendants, disgorging profits earned by Patriot28 and barring Jarkesy from the securities industry.
Jarkesy and Patriot28 appealed the decision to the Fifth Circuit, which through a split panel, vacated the final order by reasoning that the SEC’s decision to adjudicate the case “in-house” violated Jarkesy and Patriot28’s Seventh Amendment right to a jury trial. The Fifth Circuit denied rehearing the case before the Supreme Court undertook the case’s review in 2023.
In reasoning the decision, Chief Justice John Roberts explained that the SEC’s action against Jarkesy and Patrtiot28 implicated the Seventh Amendment right to a jury trial because the SEC’s antifraud provisions are derived from common law fraud principles, and it is “well established that common law claims must be heard by a jury.” Chief Justice Roberts further explained that, since the penalties sought by the SEC were designed to “punish and deter, not to compensate,” the penalties sought “could only be enforced in courts of law.” If you are under investigation by financial industry regulator, it would be prudent for you to discuss your situation with a skilled Securities Law Lawyer, like the lawyers at Malecki Law in New York.
Chief Justice Roberts next reasoned that the “public rights” exception to the Seventh Amendment did not apply to the Jarkesy case. Normally, the “public rights” exception permits Congress to assign certain matters to agencies for adjudication, rather than courts, despite agency proceedings not affording defendants the right to a jury trial. Chief Justice Roberts explained that, since the action did not involve any governmental initiatives which the Supreme Court had previously concluded could be resolved outside of court without a jury, the “public rights” exception did not apply.
In a separate decision on June 28, 2024, the Supreme Court also overruled its landmark 1984 decision in Chevron v. Natural Resources Defense Council, which gave rise to the Chevron Doctrine that afforded regulatory agencies substantial deference in interpreting their own rules absent guidance from Congress. The Chevron decision in conjunction with the Jarkesy decision is very likely to alter the SEC as we know it. The deck will no longer be uniquely stacked in the SEC’s favor. If you have received an SEC subpoena, you should speak with a seasoned Regulatory Defense law firm, like New York City’s Malecki Law.
Jarkesy has the power to completely reshape how the SEC conducts its enforcement actions moving forward. First, the SEC likely will initiate far fewer civil actions since defendants will be entitled to have the SEC’s charges adjudicated by a jury of their peers, rather than a hand-picked SEC administrative law judge. It will also take more time and hours to try a case in front of a jury, limiting the SEC’s available bandwidth. Next, the types of charges filed by the SEC are bound to change, since certain are easier to prove than others, some may be open to more subjective standards that a jury may see very differently than and more objectively than an in-house adjudicator familiar with every SEC staffer that works for the same entity. Now, the SEC and investigated person will enter the court on more equal footing. Finally, the SEC’s general operations that we are accustomed to may very well be at risk. The SEC’s funding typically comes from money the SEC recovers through its enforcement actions. If the SEC brings fewer actions under the post-Dodd-Frank civil action standards, logic follows that the SEC will have less funding to enforce securities laws and protect investors.