5th Circuit Holds SEC Administrative Enforcement Actions Unconstitutional
The U.S. Court of Appeals for the Fifth Circuit recently issued an opinion in a securities fraud case that declared several aspects of the SEC’s enforcement regime to be unconstitutional. This case continues a recent trend of constitutional challenges brought against the SEC and the CFPB.
In Jarkesy v. SEC, the court heard a challenge to an SEC administrative law judge’s (ALJ) finding that a hedge fund manager and the hedge fund’s adviser engaged in securities fraud in violation of the Dodd Frank Act. The defendants challenged the ALJ’s findings at the Fifth Circuit, and the court of appeals ruled in favor of the defendants on three grounds.
First, the Fifth Circuit determined that the SEC’s administrative proceedings in front of the ALJ violated the defendant’s Seventh Amendment rights to a jury trial. The Seventh Amendment generally provides the right to a jury trial, but parties are not entitled to a jury trial in SEC administrative actions where the SEC is enforcing public rights. Here, the court found that the SEC was enforcing private rights rather than public rights because the securities actions arose from common law fraud. The court reasoned that fraud claims are historically “about the redress of private harms.” For that reason, the defendants are entitled to a jury trial for the securities fraud claims.
Next, the court ruled that Congress unconstitutionally delegated legislative power under Article I of the Constitution to the SEC when it allowed the SEC to choose whether to bring enforcement actions in front of an SEC ALJ or a federal district judge. The court reasoned that Congress was required to give the SEC an “intelligible principle” to guide the agency on how to decide whether to bring an action using an administrative proceeding or in federal court. Here, the court found that “Congress offered no guidance whatsoever” on where to bring an action, which violated the Constitution. Note that the court also observed that courts had not used the “intelligible principle” to strike down statutes for “several decades.”
Finally, the court held that the ALJs who oversee SEC administrative proceedings enjoy unconstitutional removal protection. Under Article II of the constitution, the President must “take Care that the Laws be faithfully executed,” which the Supreme Court has interpreted to mean that the President enjoys the power to remove SEC ALJs and other officers that are sufficiently important to executing laws. Accordingly, the SEC ALJs cannot enjoy “two layers” of protection, where the President can only remove their supervisors and not the ALJs themselves. However, the ALJs in this case would be removable only after the SEC Commissioners and Merit Systems Protection Board (MSPB) members take joint action to remove them. Because the SEC Commissioners and MSPB members are removable by the President only for cause, the SEC ALJs enjoyed two layers of protection. Therefore, the court held that the SEC ALJs were unconstitutionally protected from the President’s removal power. The Fifth Circuit panel’s ruling is subject to a possible petition for rehearing by the panel or the en banc court of appeals, as well as to a petition for writ of certiorari in the Supreme Court. The SEC currently has until mid-August to petition the Supreme Court for review.
