The decision by the U.S. Court of Appeals for the Fifth Circuit requiring the Securities and Exchange Commission to adjudicate a fraud case against a hedge fund manager in federal court gives defendants the chance to make their case in front of a jury rather than before an in-house administrative law judge.  

“SEC and other enforcement agencies for too long have gotten away with denying jury-trial rights to those whom they target in enforcement actions,” said Peggy Little, senior litigation counsel at the New Civil Liberties Alliance (NCLA).

The May 18 decision in Jarkesy v. SEC is limited to actions in Texas, Louisiana and Mississippi, but it’s just the latest move challenging the SEC’s growing use of administrative law judges (ALJs), rather than jury trials, to hear its enforcement cases. 

In 2018, the U.S. The Supreme Court shot down the way the SEC selects its in-house judges, and later this month, the top court is scheduled to hear another Fifth Circuit case on the SEC’s approach to in-house hearings.

Critics have also taken issue with the SEC’s so-called no-admit, no-deny policy in which companies and individuals, in agreeing to settle charges rather than go before a judge, neither admit nor deny guilt, and are barred from later challenging facts about the case. Critics call the bar an unconstitutional gag on free speech.   

“SEC gag orders are unconstitutional prior restraints that violate Americans’ First Amendment rights and ... due process rights,” Little of NCLA has said. 

Unconstitutional transfer of authority

This latest Fifth Circuit ruling said Congress’ delegation of authority to the SEC for deciding the venue for hearing cases is unconstitutional because it gives discretion to the agency that amounts to the kind of legislative powers that only Congress can exercise.

To be constitutional, the court said, Congress must give the agency a rule for deciding which cases it can or can’t bring before an in-house judge, but it never did that.

“Congress unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise the delegated power,” Judge Jennifer Walker Elrod said in the majority opinion of the 2-1 decision. 

Statutory restrictions on the removal of the administrative law judges are also unconstitutional, the court said, because they’re given two layers of for-cause protections, which impose an inappropriate limit on the president. 

“Two layers of insulation impedes the President’s power to remove ALJs based on their exercise of the discretion granted to them,” the court said. 

Private v. public matter

For in-house legal teams and individual officers facing an SEC enforcement action, the ruling means in some cases they would be able to present their case before a jury if it involves a traditional, private matter to which the jury-trial right attaches.

“An agency … cannot assign the adjudication of such claims [to itself] because such claims do not concern public rights alone,” said the court.

The case involves George Jarkesy, the head of two investment funds that the SEC in 2011 alleged committed fraud by misrepresenting who served as the prime broker and as the auditor, what the funds’ investment parameters and safeguards were and overvalued the funds’ assets to increase the fees that they could charge investors. 

The SEC in 2013 brought the case before an administrative law judge, who found in favor of the SEC and levied a $300,000 fine and sought the clawback of $685,000 in ill-gotten gains. 

Jarkesy appealed the decision to the SEC but before it could be decided the Supreme Court came out with its 2018 ruling invalidating the SEC’s selection process for its judges. The SEC gave Jarkesy and other past defendants a chance to have their cases retried by appropriately selected judges but Jarkesy went before the Fifth Circuit instead to challenge the SEC’s use of in-house judges.

The SEC argued Jarkesy was appropriately heard by an internal judge because it involved the kind of public interest for which Congress delegated authority to agencies such as the SEC to manage, and the court didn’t disagree. But it said the case also involved a private interest, because the fine and the disgorgement the SEC was seeking are the kind of liability determination that is appropriate for a civil jury to hear. 

“The actions the SEC brought seeking civil penalties under securities statutes are akin to those same traditional actions in debt,” the court said.

The SEC in a statement said it was “assessing the decision to determine appropriate next steps,” the New York Times reported.