Where may the Securities and Exchange Commission (SEC) bring its enforcement actions on claims of securities fraud — (a) in its own administrative tribunals, as it regularly has for decades, or (b) in Federal District Court, where the defendant is entitled to a jury trial? This issue lay at the heart of a case recently decided by the Supreme Court — Securities and Exchange Commission v. George R. Jarkesy, Jr., et al., 603 U.S. ___, S. Ct. (June 27, 2024). The Supreme Court considered whether the SEC’s enforcement actions on claims of securities fraud were akin to traditional actions of law and whether the Seventh Amendment, therefore, guaranteed a defendant’s right to a jury trial in the Federal District Court.

The court drastically changed the landscape and held that the SEC must bring an enforcement action regarding claims of securities fraud in the Federal District Court, holding that “[w]hen the SEC seeks civil penalties against a defendant for securities fraud, the Seventh Amendment entitles the defendant to a jury trial.”

The court’s opinion will materially impact where and how the SEC seeks to bring its future enforcement actions.

Legal Background

The SEC is responsible for detecting and investigating a wide range of potential violations of federal securities laws and regulations. Securities laws prohibit fraudulent conduct both criminally and civilly, but the SEC is responsible only for civil enforcement and administrative actions.

The SEC, like other federal regulatory bodies, brings many of its enforcement actions in its internal administrative tribunals, which are presided over by the SEC’s own administrative law judges (ALJs). Historically, the SEC had authority to choose whether to bring enforcement actions within the agency or in Federal District Court.

While the Seventh Amendment guarantees a defendant’s right to a jury trial, the Supreme Court of the United States has previously held that agency adjudication before an ALJ — like those conducted in the SEC — is constitutional, despite the absence of a jury. See Atlas Roofing Co. v. Occupational Safety & Health Rev. Comm’n, 430 U.S. 442, 455, 97 S.Ct. 1261, 51 L.Ed.2d 464 (1977). Whether Congress may properly assign an action to administrative adjudication depends on whether the proceedings center on “public rights.” Id. at 450, 97 S.Ct. 1261. “[I]n cases in which ‘public rights’ are being litigated[,] e.g., cases in which the Government sues in its sovereign capacity to enforce public rights created by statutes within the power of Congress to enact[,] the Seventh Amendment does not prohibit Congress from assigning the factfinding function and initial adjudication to an administrative forum with which the jury would be incompatible.” Id.

Factual and Procedural Background of the Case Before the Court

George Jarkesy established two hedge funds and selected Patriot28 as the investment adviser. The funds brought in over 100 investors and held about $24 million in assets. In 2011, the SEC launched an investigation into Jarkesy and Patriot28’s investing activities, and a couple of years later, the SEC chose to bring an action within the agency, alleging that they — along with some former co-parties — committed fraud under the Securities Act of 1933, the Securities Exchange Act, and the Investment Advisers Act of 1940. Specifically, the SEC charged that Jarkesy and Patriot28: (1) misrepresented who served as the prime broker and as the auditor; (2) misrepresented the funds’ investment parameters and safeguards; and (3) overvalued the funds’ assets to increase the fees that they could charge investors.

The SEC found that Jarkesy and Patriot28 committed various forms of securities fraud. The SEC ordered Jarkesy and Patriot28 to cease and desist from committing further violations and to pay a civil penalty of $300,000, and it ordered Patriot28 to disgorge nearly $685,000 in “ill-gotten gains.” The SEC also barred Jarkesy from the securities industry.

Jarkesy and Patriot28 appealed to the Fifth Circuit Court of Appeals. In a divided opinion, the Fifth Circuit found in favor of Jarkesy and Patriot28, holding that they were deprived of their right under the Seventh Amendment to a jury trial on the securities fraud claims brought by the SEC. Jarkesy v. Sec. & Exch. Comm’n, 34 F.4th 446, 449 (5th Cir. 2022). The Fifth Circuit reasoned that the rights that the SEC sought to vindicate in its enforcement action arise “at common law” under the Seventh Amendment, as the fraud claims are rooted in common-law principles. Id.

The SEC petitioned for Supreme Court review, and the Supreme Court granted certiorari.

The Court’s Groundbreaking Opinion

In a 6-3 decision, the Supreme Court affirmed.

The court first discussed how the SEC’s enforcement action implicated the Seventh Amendment, holding that because the remedy in the SEC’s enforcement action was a civil penalty, which is “designed to punish and deter, not to compensate,” the civil penalty “could only be enforced in courts of law.” The court additionally noted that “the close relationship between federal securities fraud and common law fraud” implicates the Seventh Amendment, as securities fraud claims are “legal in nature.”

The court then distinguished this case from Atlas Roofing, holding that because the SEC’s enforcement securities fraud actions “target the same basic conduct as common law fraud, employ the same terms of art, and operate pursuant to similar legal principles,” these actions are a matter of private, not public, right. Accordingly, the court held that neither Congress nor the SEC can withdraw a matter from “judicial cognizance” and “strip its target of the protections of the Seventh Amendment.”

For these reasons, the Supreme Court held that “[a] defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator.”

Justice Sotomayor, joined by Justices Kagan and Jackson, dissented, rejecting the majority’s opinion and calling it a “massive sea change” for federal agencies. Relying on the Supreme Court’s precedent, Justice Sotomayor, for the dissent, stated that “[a] faithful application of our precedent would have led, inexorably, to upholding the statutory scheme that Congress enacted for the SEC’s in-house adjudication of federal-securities claims.”  Justice Sotomayor also focused on the practicability of the SEC enforcing its own rules and regulations, noting that the enforcement scheme “may yield important benefits over jury trials in federal court, such as greater efficiency and expertise, transparency and reasoned decisionmaking…”

The Critical Takeaways

The Supreme Court’s Jarkesy decision will have broad-sweeping implications for the SEC and all federal agencies that enforce their rules through administrative tribunals. At issue in Jarkesy were securities fraud claims; however, the SEC has, under the powers given to it by Congress, adopted a number of rules and created causes of action unknown to the common law. It is unclear whether the ruling in Jarkesy will impact the SEC’s ability to enforce these rules and causes of action in its administrative tribunal, and future court challenges could very well be seen soon.

Taft’s Securities Litigation and Enforcement Defense attorneys are seasoned problem solvers and trusted advisors to clients in all manners of securities cases from pre-litigation strategies through motion practice, trials, and appeals. Taft’s securities litigators routinely defend public companies and their officers and directors in SEC enforcement actions and investigations, securities litigation, and shareholder derivative actions.