The constitutionality of the United States Securities and Exchange Commission's (SEC) system of administrative tribunals has long been the subject of fierce debate. Defendants in cases brought by the SEC in-house have raised a bevy of constitutional challenges to the proceedings, ranging from the appointment (and removal) of the Commission's administrative law judges, to the scope of constitutional protections afforded to defendants, to the Commission's discretion to select the venue for prosecution. Even though the ultimate import of the defendants' claims is that the proceedings are unconstitutional, the courts have generally declined to hear these challenges until the proceedings have concluded, citing principles of exhaustion and the provisions of the Securities Exchange Act of 1934 that vest jurisdiction to review SEC orders exclusively in the federal courts of appeals. In the wake of the Supreme Court's ruling in Lucia v. SEC, 138 S. Ct. 2044 (2018), that the appointment of the Commission's ALJs violated the Appointments Clause of the Constitution, federal courts have begun to take a harder look at this system.

Last week, the Fifth Circuit issued an opinion sharply critical of the SEC's administrative tribunals. The decision, Jarkesy v. SEC, No. 20-61007 (5th Cir. May 18, 2022), has significant consequences for how the Commission can prosecute civil securities law violations and how parties facing SEC charges can seek to vindicate their constitutional rights.

In Jarkesy, the SEC brought administrative charges against a hedge fund manager and the fund's investment advisor, alleging fraud under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisors Act of 1940. The defendants sued in the United States District Court for the District of Columbia to enjoin the agency proceedings, contending that the conduct of the proceedings infringed on their constitutional rights. The district court denied relief, holding that the Exchange Act created a comprehensive scheme for reviewing SEC orders that reserved jurisdiction for the federal courts of appeals at the end of the proceedings, and the D.C. Circuit affirmed. See Jarkesy v. SEC, 48 F. Supp. 3d 32 (D.D.C. 2014), aff'd, 803 F.3d 9 (D.C. Cir. 2015). The case moved forward before an ALJ, who found the defendants liable for securities fraud, and the SEC upheld the ALJ's decision. In the process, the Commission rejected the defendants' constitutional arguments, including that the proceedings violated their right to a jury trial under the Seventh Amendment, that the Commission had exercised an unconstitutionally delegated legislative power in choosing to proceed in-house and that the ALJs were unconstitutionally insulated from removal in violation of the Take Care Clause. The defendants then petitioned the Fifth Circuit for review of the SEC's order.

A divided panel of the Fifth Circuit agreed with Jarkesy on each of the constitutional points.

  • First, the court held that the Seventh Amendment's guarantee of the right to a jury trial attached to the SEC's enforcement action. Jarkesy, slip op. at 5. In the Fifth Circuit's view, the action was "akin to traditional actions at law to which the jury-trial right attaches," and "Congress, or an agency acting pursuant to congressional authorization, cannot assign the adjudication of such claims to an agency because such claims do not concern public rights alone." Id. The court explained that requisites of the Supreme Court's "public rights" precedents, which authorize Congress to assign adjudicative functions to an administrative forum when the government sues in its sovereign capacity to enforce public rights created by federal statute, were not satisfied in this context. Id. at 7–18. Securities fraud claims, like other fraud claims, arise at common law, and allowing jury trials in securities fraud suits would not "dismantle the statutory scheme" or "impede swift resolution" of prosecutions. Id. at 11. Further, the harms at issue, and the associated rights to be vindicated, are "quintessentially . . . private," and the mere fact of the government's involvement cannot "convert a suit about private rights into one about public rights." Id. at 17, 18.
  • Second, the court held that Congress unconstitutionally delegated legislative power to the SEC when it gave the Commission "unfettered authority" in the Exchange Act, via Dodd–Frank, to choose an enforcement venue. Id. at 18. Citing the non-delegation doctrine, which provides that "Congress may grant regulatory power to another entity only if it provides an 'intelligible principle' by which the recipient of the power can exercise it," the court concluded that the decision to assign a case to agency adjudication is a legislative power and that the SEC's "exclusive authority and absolute discretion" under the Exchange Act lacks an intelligible principle. Id. at 22–25.
  • Lastly, the court held that the two layers of for-cause protection afforded the SEC's ALJs unconstitutionally impede the President's ability to control "executive officers" under the Take Care Clause. Id. at 25–29. Given the Supreme Court's holding in Lucia that the Commission's ALJs are "inferior officers" for purposes of the Appointments Clause, the Fifth Circuit observed, these officers "are sufficiently important to executing the laws that the Constitution requires that the President be able to exercise authority over their functions"; yet they may be removed only by the Commission for "good cause" found by the Merit Systems Protection Board after a hearing, and members of both the MSPB and the Commission likewise may be removed only by the President for "good cause." Id. at 28. This, the court said, presented an Article II problem. Id. at 29–30. The court therefore vacated the SEC's order and remanded the case for further proceedings. Id. at 30.

Jarkesy was not the only significant decision for the SEC in recent weeks. Two days before the Fifth Circuit handed down its opinion in Jarkesy, the Supreme Court granted certiorari in SEC v. Cochran, another decision from the Fifth Circuit bearing on challenges to the Commission's administrative tribunals. Cochran squarely presents the question rejected by the D.C. federal courts at the injunction stage of Jarkesy: "Whether a federal district court has jurisdiction to hear a suit in which the respondent in an ongoing SEC administrative proceeding seeks to enjoin that proceeding, based on an alleged constitutional defect in the statutory provisions that govern the removal of the ALJ who will conduct the proceeding." In brief, the defendant in Cochran sued in Texas federal court to enjoin an SEC in-house proceeding based on the Take Care Clause violation recently found in Jarkesy. While the district court dismissed the suit on the same jurisdictional grounds as the D.C. courts, the en banc Fifth Circuit reversed and allowed the case to proceed. See Cochran v. SEC, 20 F.4th 194, 197–98 (5th Cir. 2021) (en banc). Cochran, therefore, may open the door to pre-enforcement suits to enjoin SEC administrative proceedings—at least where the constitutionality of the proceedings is in question.

These developments merit close attention among public companies and those in the financial sector. Key takeaways include:

  • The Fifth Circuit in Jarkesy found three separate constitutional violations in the SEC's administrative tribunals. The first, centering on the right to a jury trial under the Seventh Amendment, is specific to securities fraud claims; the other two, relating to the non-delegation doctrine and the Take Care Clause, sweep more broadly. Therefore, defendants facing administrative charges of securities fraud may want to consider invoking their Seventh Amendment right to a jury trial, and all defendants, regardless of the SEC's charges, now have grounds to challenge the constitutionality of the proceedings.
  • Because it had vacated the SEC's judgment on Seventh Amendment and non-delegation grounds, the Fifth Circuit expressly declined to decide whether vacatur would be the appropriate remedy for the Take Care Clause violation alone. Jarkesy, slip op. at 25 n.17. While this is now an open question, as a practical matter, it is unlikely to have a material effect on challenges to ongoing cases because the non-delegation issue is present in every SEC administrative proceeding.
  • Together with vacating the SEC's order, the Fifth Circuit remanded the matter to the Commission for further proceedings. In theory, the only avenue now available to the SEC is to file suit in federal court. This raises all kinds of thorny legal issues, however, including, most pressingly, the application of the statute of limitations.
  • The Fifth Circuit’s opinion (authored by Judge Elrod and joined by Judge Oldham) drew a dissent from Judge Davis. According to the dissent, the panel majority had placed the court out of line with its sister circuits, at least on the application of the "public rights" standard and the associated right to a jury trial. Indeed, the Fifth Circuit's strict conception of "public rights" casts doubt on the constitutionality of all kinds of in-house agency enforcement actions beyond the SEC. This makes it more likely that the full Fifth Circuit may agree to hear the case en banc if the Commission requests review or an individual judge calls for a vote, and that the Supreme Court may grant certiorari if the decision stands.
  • If the Supreme Court agrees with the Fifth Circuit's ruling in Cochran, parties facing SEC administrative charges would no longer need to submit to the proceedings before raising a constitutional or ultra vires challenge in federal court. This would represent a significant change to the doctrine set forth in Thunder Basin Coal Co. v. Reich, 510 US 200 (1994), and its progeny (including Free Enterprise Fund v. PCAOB, 561 US 477 (2010), and Elgin v. Dep't of Treasury, 567 US 1 (2012)), that the existence of a comprehensive statutory scheme for review of agency action generally precludes federal jurisdiction over pre-enforcement challenges. While Cochran is focused on the Exchange Act's jurisdictional provisions, the Supreme Court could well issue a decision that reverberates through other agency enforcement actions. Indeed, the Court already has agreed to hear another case involving a similar statutory scheme, Axon Enterprise v. FTC, which presents the question of "[w]hether Congress impliedly stripped federal district courts of jurisdiction over constitutional challenges to the Federal Trade Commission's structure, procedures and existence by granting the courts of appeals jurisdiction to 'affirm, enforce, modify or set aside the Commission's cease-and-desist orders." Together, Cochran and Axon should clarify the circumstances under which a party facing administrative charges can short-circuit the onerous review process and present an Article III court with pre-enforcement challenges to the agency's action.


Co-Head of Regulatory, Investigations, Securities and Compliance, United States
Head of White-Collar and Co-Head of RISC, United States

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