A recent decision by the Fifth Circuit Court of Appeals, which covers Louisiana, Mississippi, and Texas, has determined that the Securities and Exchange Commission’s (SEC) in-house process for handling cases is a violation of the Seventh Amendment to the United States Constitution. The Seventh Amendment guarantees the right to a jury trial in federal civil cases when the amount in question exceeds twenty dollars. The court in Jarkesy v. SEC held that the proceedings at the SEC “suffered from three independent constitutional defects: (1) Petitioners were deprived of their constitutional right to a jury trial; (2) Congress unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise the delegated power; and (3) statutory removal restrictions on SEC Administrative Law Judges (ALJs) violate Article II.”


George Jarkesy formed two hedge funds, which raised approximately $24 million from over 100 investors. The SEC charged both Jarkesy and his investment advisor, Patriot28, with securities fraud under various federal acts. The action against Jarkesy also alleged misrepresentations regarding the funds’ prime broker and auditor, the funds’ safeguards, and the value of the funds’ assets. The SEC’s administrative judge held an evidentiary hearing wherein he found both Jarkesy and Partriot28 had committed securities fraud. The SEC rejected the initial appeal and ordered respondents to cease and desist further violations and to pay a civil penalty of $300,000. Patriot28 was also ordered disgorgement of $685,000, while Jarkesy was barred from engaging in various securities industry activities. This decision was then appealed to the Fifth Circuit Court of Appeals.


Moving forward, this holding may be problematic for not only the SEC, but also other federal agencies. Many federal agencies, like the SEC, employ their own in-house administrative judges to streamline enforcement or disciplinary actions. While these ALJs are supposed to remain impartial, cases tried in front of in-house administrative judges almost overwhelmingly go in favor of the agency. Additionally, with Respondent’s facing the uncertainty of presenting their case before the gauntlet of an SEC-employed prosecutor and an SEC-employed judge, most will opt for a settlement offer from the government.

The extent of this case’s reach has yet to be fully determined. The SEC will likely petition for an en banc review before the Fifth Circuit, or it is possible that this case will be petitioned to the Supreme Court of the United States for review. When these cases are finally heard, it will be interesting to see if the ruling will be applied to the many other agencies utilizing their own in-house administrative judges. In the meantime, the SEC will need to file its actions in federal court.

NASBA provides the latest information on SEC Enforcement and Litigation in the Enforcement Resources Committee’s Quarterly Enforcement Report.

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