Supreme Court Finds Key SEC Enforcement Mechanism Unconstitutional

Today, the Supreme Court upheld a ruling by the Fifth Circuit (remember them?) that significantly limits the SEC’s (and potentially other regulatory agencies’) powers of enforcement. 

The Dodd-Frank Act adopted in 2010 authorized the SEC to impose civil fines against defendants accused of fraud through its own in-house proceedings whereby the case is prosecuted by the SEC’s Division of Enforcement and adjudicated by the full the SEC or more commonly, to a delegate (most typically an administrative law judge employed by the SEC) whose decision is subject to review by the SEC. The alternative (and the only option available to the SEC prior to the passage of Dodd-Frank) would be for the SEC to bring suit in federal court where the defendant would be entitled to a trial by jury, presided over by a judge appointed pursuant to Article III of the Constitution, and subject to the Federal Rules of Evidence. 

Unsurprisingly, since being granted the authority to do so, the SEC has frequently chosen to pursue these matters in-house. The Supreme Court’s holding in SEC v. Jarkesy is that this practice is unconstitutional in matters where the SEC is seeking civil penalties on the basis that it violates the defendant’s right to a trial by jury pursuant to the Seventh Amendment. The SEC is one of many federal regulatory agencies that use administrative law judges to enforce their rules through the imposition of civil penalties, and the ruling has the potential to have far-reaching consequences beyond just the SEC. For our purposes, however, while the ruling does impose significant limitations on the SEC’s ability to obtain civil penalties through its in-house administrative proceedings, it bears mentioning that this was not the worst possible outcome for the SEC in this case. In focusing its ruling exclusively on the applicability of the Seventh Amendment, the Supreme Court skirted certain other constitutional questions raised by the case where an adverse ruling could have had even broader implications for the SEC. For example, the narrower scope of the ruling leaves intact (for now) the SEC’s ability to pursue other remedies through administrative proceedings where the defendant does not have the right to a jury trial under the Seventh Amendment, such as barring individuals from associating with SEC-registered entities or from practicing before the SEC. 

Of course, the SEC’s terrible, horrible, no good, very bad month still has the potential to get even worse as the Supreme Court is expected to rule this week in two other cases (Loper Bright Enterprises v. Raimondo and Relentless, Inc. v, Department of Commerce) challenging the concept of so-called “Chevron deference,” a longstanding precedent that courts should defer to a federal agency’s interpretation of the laws that created and empowered the agency where there is ambiguity in the law and the agency’s interpretation is reasonable. A ruling that overturns or curtails the principle of Chevron deference (which many observers of the Supreme Court are predicting will be the outcome) would be yet another significant blow to the SEC.