In a win for conservatives, Supreme Court limits use of SEC in-house tribunals

A divided Supreme Court on Thursday invalidated the Securities and Exchange Commission’s use of in-house legal proceedings to discipline those it believes have committed fraud - a blow to the SEC that liberal justices and some outside experts said would significantly curb the enforcement power of a host of other federal agencies.

In a 6-3 ruling that broke along ideological lines, the court said the SEC’s reliance on internal tribunals, rather than federal courts, to bring enforcement actions in securities fraud cases violates the Constitution. The case is the latest in a string of rulings by the high court paring back the powers of the so-called administrative state.

The justices were reviewing a ruling from the U.S. Court of Appeals for the 5th Circuit that said the SEC’s in-house tribunals violated the Seventh Amendment, which guarantees the right to a jury trial. The appeals court said Congress exceeded its power in allowing such tribunals and that the job security provided to administrative law judges who hear such cases infringed on the executive branch’s prerogatives. The Supreme Court did not rule on the latter issue.

Writing for a majority that included all of the court’s conservatives, Chief Justice John G. Roberts Jr. said a defendant facing a fraud suit has “the right to be tried by a jury of his peers before a neutral adjudicator. Rather than recognize that right, the dissent would permit Congress to concentrate the roles of prosecutor, judge, and jury in the hands of the Executive Branch.”

In dissent, Justice Sonia Sotomayor warned of a “massive sea change” for federal agencies following the case known as SEC v. Jarkesy and said the ruling took a “wrecking ball” to settled law. Sotomayor read her dissent from the bench, a step that indicated her strong disapproval of the majority’s decision.

“The constitutionality of hundreds of statutes may now be in peril, and dozens of agencies could be stripped of their power to enforce laws enacted by Congress,” wrote Sotomayor, joined by Justices Elena Kagan and Ketanji Brown Jackson. “Rather than acknowledge the earthshattering nature of its holding, the majority has tried to disguise it.”

Jody Freeman, a law professor at Harvard who worked in the Obama administration, agreed the ruling would reverberate beyond the SEC. More than two dozen agencies can launch administrative proceedings, including the Federal Communications Commission, Environmental Protection Agency and Justice Department.

“In one sense, the court’s decision showed restraint because it sidestepped big questions about whether Congress can even set up agencies like the SEC the way it has and give them important regulatory powers,” Freeman said. “On the other hand, Jarkesy is a significant constraint on agency enforcement power - call it another notable nip at the administrative state. It will hamper not just the SEC but many other agencies by making it harder to enforce statutes against violators.”

Jon Michaels, a professor at the University of California at Los Angeles School of Law who is an expert on administrative law, said federal agencies are likely to bring fewer enforcement actions as a result of the ruling.

“Requiring a jury trial is a huge deal in terms of time and resources,” Michaels said. “We’re already at a point where a lot of agency enforcement actions don’t go far anyway because agencies are so stressed in terms of time and people power.”

But Tom Lee, a professor of law at Fordham University, noted that most in-house tribunals at other agencies deal with matters like social security benefits and immigration-rights determinations, which would not require a jury trial under this ruling.

Analysts who see the federal government as having amassed too much power said the decision was a necessary correction. Rob Johnson, an attorney for the conservative Institute for Justice, said the high court’s supermajority had restored fundamental constitutional safeguards with its ruling.

“Jury trials were the norm for most of the country’s history, but since the 1970s scores of federal agencies have claimed the power to impose fines through in-house administrative courts, where judge and prosecutor are employed by the same agency,” Johnson said in a statement.

The challenge was brought by George Jarkesy, who set up two hedge funds and used a company named Patriot28 LLC to advise on those investments. The funds had more than 100 investors and about $24 million in assets.

The SEC launched an investigation into Jarkesy and Patriot28′s investing activities in 2011, and the agency alleged in 2013 that the company made several misrepresentations and overvalued the funds’ assets to increase fees charged to investors.

Jarkesy and the companies represented to brokers and investors that a prominent accounting firm served as the auditor for the funds and that a prominent investment bank served as their prime broker, the government said in its brief, even though “the firm never audited the funds and the bank never opened a prime brokerage account for them.”

After an internal tribunal found the violations, the SEC ordered Jarkesy and Patriot28 to pay $300,000 in a civil penalty and turn over nearly $685,000 in illicit profits.

Individuals and entities who face such proceedings have the right to challenge adverse rulings in federal court. Jarkesy did so, and the conservative appeals court threw out the findings against him on three grounds: that they violated the Seventh Amendment, that Congress exceeded its powers in allowing the SEC the choice to bring actions either in-house or in district court, and that the removal procedures for administrative law judges who hear such proceedings provide too much protection.

Kagan said during oral arguments in SEC v. Jarkesy that the 5th Circuit ruling contradicted a 1977 opinion by the high court that backed the powers of a workplace safety commission to conduct administrative hearings. That case, Atlas Roofing Co. v. Occupational Safety and Health Review Commission came up more than 100 times during the November discussion. But the majority found the ruling did not apply in Jarkesy.

The SEC, which was formed in the wake of the stock market crash of 1929 and the Great Depression that followed, is tasked with protecting investors and regulating markets.

The SEC case is one of a series that the Supreme Court is hearing this term that could reshape the regulatory power of the federal government. Also on Thursday, the high court put a hold an ambitious plan by the EPA to regulate air pollution that drifts across state lines.

Last month, the Supreme Court rejected a broad challenge to the powerful Consumer Financial Protection Bureau, which would have undermined the agency established to protect borrowers from predatory lenders, excessive fees and other abuses in the wake of the 2008 financial crisis. In a 7-2 decision authored by Justice Clarence Thomas, the majority found the agency’s funding mechanism to be constitutional.

Two cases still to be decided seek to overturn a major ruling that requires courts defer to federal agency’s reasonable interpretations of ambiguous laws. Lower courts still rely on the precedent known as Chevron, but the Supreme Court has moved away from its holdings in recent years.

In a statement, Jarkesy applauded the ruling saying “after a decade of gross misconduct and blatantly unconstitutional political attacks from the SEC and their in-house court, today the United States Supreme Court ruled that the Constitution still matters.”