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SEC’s Use of Administrative Proceedings Ruled Unconstitutional by Court of Appeals SEC’s Use of Administrative Proceedings Ruled Unconstitutional by Court of Appeals

SEC’s Use of Administrative Proceedings Ruled Unconstitutional by Court of Appeals

Last week, the Court of Appeals for the Fifth Circuit ruled that the U.S. Securities and Exchange Commission’s (SEC’s) use of an administrative proceeding was unconstitutional. Administrative proceedings are an alternative to the filing of a civil complaint in federal court in which the case is decided by an in-house SEC judge in an administrative forum. 

In a split decision issued on May 18, the Fifth Circuit panel ruled that the SEC violated a hedge fund manager’s Seventh Amendment right to a jury trial when it let the SEC’s in-house judge decide the case. The court acknowledged that in-house adjudication of claims could be permissible for certain cases that center on “public rights.” This case, however, involved claims, in the form of fraud allegations, and remedies, in the form of a civil penalty, “akin” to those that arise under common law for which the right to a jury attaches.

The panel went even further, holding that the SEC’s in-house judges are unconstitutionally protected from removal because there are at least two layers of for-cause protection. Administrative law judges can be removed only for good cause as determined by the Merit Systems Protection Board and then acted on by the SEC commissioners. Both of those sets of officials are removable only for good cause by the President. 

In addition, the court found fault with the SEC’s ability to choose between administrative proceedings and federal court actions, holding that Congress unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise this power.

The SEC’s use of administrative proceedings has been challenged numerous times since 2010, when the Dodd-Frank Act expanded the types of enforcement cases the SEC could pursue in that forum. In 2018, the U.S. Supreme Court ruled, in Lucia v. SEC, that the SEC could not staff its proceedings with administrative law judges hired through the civil service process rather than formal appointments.

The SEC can seek review by the U.S. Supreme Court. However, this case may have far-reaching consequences on the SEC’s ability to bring an enforcement action outside of federal court. The SEC typically brings fewer cases in federal court as opposed to administrative proceedings. While this decision may not affect the SEC’s ability to bring administrative proceedings for uncontested cases where the SEC and defendant have agreed in advance to settle the matter, the agency may be forced to pursue contested disputes in U.S. district court. This decision could also have implications for other federal agencies that, like the SEC, pursue administrative proceedings for some enforcement actions.

The case is Jarkesy, et al. v. SEC, No. 20-61007.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.
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