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Fifth Circuit Questions the Constitutionality of SEC Administrative Proceedings

In a groundbreaking decision that has sent ripples through the legal community, the United States Court of Appeals for the Fifth Circuit has raised serious questions about the constitutional legitimacy of the Securities and Exchange Commission's (SEC) internal enforcement procedures. The case, known as Jarkesy v. SEC, has the potential to reshape not only the SEC's enforcement landscape but also the administrative enforcement actions of various other federal agencies.

A Closer Look at the Case Background

Several years ago, the SEC initiated an administrative action against George Jarkesy, the founder of two hedge funds, and their investment advisor, John Thomas Capital Management Group. The SEC accused them of securities fraud, including misrepresentations and omissions to investors. The defendants sought relief from federal courts to halt the SEC's administrative proceedings, but their request was denied. Subsequently, an SEC Administrative Law Judge (ALJ) ruled against them, imposing a civil penalty and other sanctions. The SEC affirmed this decision, leading to an appeal to the Fifth Circuit.

Unpacking the Constitutional Concerns

The Fifth Circuit's ruling was particularly noteworthy for its agreement with three major constitutional objections raised by the petitioners:

1. Seventh Amendment Concerns: The court opined that the SEC's internal adjudication process violated the petitioners' Seventh Amendment right to a jury trial. The court elaborated that civil penalty actions, such as those brought by the SEC, are fundamentally rooted in common-law claims. As such, they trigger the Seventh Amendment's guarantee of a jury trial.
2. Non-Delegation Doctrine: The court went further to question the SEC's discretionary power to opt between administrative proceedings and federal court actions for securities fraud cases. It found this to be an unconstitutional delegation of legislative authority, emphasizing that Congress had not provided adequate guidelines to govern the SEC's decision-making in this regard.
3. Removal Restrictions for ALJs: The court also took issue with the statutory protections that prevent the removal of SEC ALJs. It ruled that these protections are unconstitutional as they excessively limit the President's power to oversee the Executive Branch, thereby undermining the separation of powers.

The Far-Reaching Implications

The Jarkesy decision, if upheld, could have monumental implications:

• - SEC Enforcement Actions: The ruling would necessitate that all SEC enforcement actions seeking civil penalties be tried by a jury. This would be a significant departure from the current practice and could slow down the enforcement process. - Venue for SEC Cases: The SEC would likely be compelled to bring all contested matters to federal district courts, where defendants benefit from full discovery rights and are subject to the Federal Rules of Evidence.
• - Impact on Other Federal Agencies: The decision could extend beyond the SEC and influence how other federal agencies conduct administrative enforcement actions. This could lead to a reevaluation of the administrative powers vested in federal agencies.
• - Legislative Response: Congress may need to intervene to provide clearer guidelines for the SEC and other agencies, thereby addressing the court's non-delegation concerns.

Conclusion and Future Outlook

The Jarkesy ruling is a watershed moment in administrative law and its impact will be closely watched. It remains to be seen whether this decision will be appealed to the Supreme Court or whether Congress will take legislative action to address the constitutional issues raised.

For further inquiries, please contact our Securities Litigation & SEC Enforcement team at Lucosky Brookman LLP.