Review of SEC v. Jarkesy, and its impact on the Securities Industry

Headline news describes the decision as striking a “serious blow against the administrative state.” See Emily Peck, Supreme Court strikes serious blow against the administrative state, Axios, June 27, 2024, https://www.axios.com/2024/06/27/scotus-sec-jarkesy-decision. The impact of this case is expected to be felt for years to come.

I. Facts of the Case.

George Jarkesy launched two investment funds, raising about $24 million from 120 accredited investors. Jarkesy, 603 US at 4. Patriot28, also managed by Jarkesy, served as the funds’ investment adviser. Id. The SEC brought an enforcement action against Jarkesy for violating the antifraud provisions of the Securities Act, the Securities Exchange Act, and the Investment Advisers Act, and sought civil penalties and other remedies. Id. at 5. 

The SEC adjudicated the matter internally and the administrative law judge issued an initial decision. Id. The decision was reviewed and a final order levied a civil penalty of $300,000 against Jarkesy and Patriot28, ordered disgorgement, and prohibited Jarkesy from participating in the securities industry and offering of penny stocks. Id. Jarkesy and Patriot28 petitioned for judicial review and the Fifth Circuit determined that a jury trial would be required if the case was brought in an Article III court. Id. at 6. The Fifth Circuit further found that the “public rights” exception, which permits Congress to assign an action to an agency tribunal without a jury, did not apply in this case. Id.

II. Issue before the Court.

Does the Seventh Amendment entitle a defendant to a jury trial when the SEC seeks civil penalties against him for securities fraud? 

III. The Court’s Holding.

The SEC’s antifraud provisions, which replicate common law fraud, must be heard by a jury. Id. at 6. The “public rights” exception, which has been held to permit Congress to assign certain matters to agencies for adjudication even though such proceedings would not afford the right to a jury trial does not apply because the case does not fall within any distinctive areas involving governmental prerogatives where the Court has concluded may be resolved outside of an Article III court without a jury. Id. at 7.

IV. The Court’s Legal Analysis.

The Court carefully upheld a defendant’s right to trial by jury in cases involving antifraud provisions of the Securities Act, the Securities Exchange Act, and the Investment Advisers Act. The Court did not expand a defendant’s right to a jury trial to all government enforcement actions. In determining whether a defendant has a right to a jury trial, the Court clarified that the Seventh Amendment “embraces all suits which are not of equity or admiralty jurisdiction, whatever may be the peculiar form which they may assume. Id. at 8 (citations omitted). To determine whether a cause of action sounds in law or equity, the Court held that the “remedy was the more important consideration.” Id. at 9 (citations omitted). Money damages “designed to punish or deter the wrongdoer” generally signal that the suit is sound in law. Id. On the other hand, money damages “solely to restore the status quo” would sound in equity. Id. In other words, SEC civil penalties arise from a suit in law and are thus subject to the Seventh Amendment. Id. at 13. Remedies such as disgorgement or restitution, which were not specifically discussed by the Court, may instead arise from a suit in equity. 

The Court also heavily limited the “public rights” exception, which allows Congress to assign matters dealing with public rights for decision to an agency without a jury. Id. at 14. The Court rejected the SEC’s argument that the public rights exception applies simply because the government was the plaintiff. Id. at 22. The Court does not definitively explain the distinction between public and private rights. Id. at 17. Public rights include actions related to the relations with Indian tribes, administration of public lands, and granting of public benefits such as payments to veterans, pensions, and patent rights to fall. Id. On the other hand, private rights involve claims “from its nature subject to a suit at common law.” Id. at 19 (cleaned up). Actions for fraudulent conduct with punitive remedies that could only be enforced in a court of law would involve a matter of private rather than public right. Id. at 21. 

The dissent called the Court’s decision a “massive sea change” and a reason for litigants seeking to dismantle the “administrative state” to rejoice. Id. at 35. The decision means that 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.” Id.  

V. Impact of Jarkesy.

As the dissent in Jarkesy warns, Jarkesy places a lot of federal agencies under scrutiny. As an immediate impact, the SEC will likely have to bring a large sum of their enforcement actions in an Article III court, rather than internally with its administrative law judges. Other federal agencies may soon have to follow suit. While Jarkesy intentionally limits its holding to civil penalties for securities fraud, the decision could be broadly read to subject all civil penalties designed to punish wrongdoers, rather than restore the status quo, to the Seventh Amendment. Many civil penalties issued by the federal government are meant to deter wrongdoers, and defendants may now have the right to a jury trial in all such matters. The hamstrung public rights exception leaves the door wide open for countless challenges to such civil penalties under the right to a jury trial. 

Jarkesy does not directly apply to state administrative agencies. The right to a jury trial under the Seventh Amendment has not been incorporated into the states. See City of Monterey v. Del Monte Dunes at Monterey, Ltd., 526 U.S. 687, 119 S. Ct. 1624, 143 L. Ed. 2d 882 (1999). The Arizona Corporate Commission generally only brings cases dealing with state laws, so state courts generally would have jurisdiction. Grable & Sons Metal Products, Inc. v. Darue Eng’g & Mfg., 545 U.S. 308, 308, 125 S. Ct. 2363, 2364, 162 L. Ed. 2d 257 (2005) (finding that federal courts have jurisdiction over state law claims only if the claims “turn on substantial questions of federal law.”).  

In a recent Arizona case, the Arizona Corporation Commission initiated an internal administrative action against the respondent for violating the Arizona Securities Act. Peterson v. Arizona Corp. Comm’n, 1 CA-CV 23-0253, 2024 WL 1167387, at *1 (App. Mar. 19, 2024). The respondent filed a special action on several grounds, including the argument that an administrative law judge cannot constitutionally adjudicate the matter. Id. at 2 ¶9. The respondent argued that under the Fifth Circuit’s Jarkesy decision, he had a right to a jury trial. Id. Respondent’s argument was rejected by the Arizona Court of Appeals, which found that Jarkesy will not be binding for the interpretation of Arizona administrative procedures because the case only construes federal law in view of the Seventh Amendment right to a jury trial. Id. at 2 ¶10.  

Despite the decision in Peterson, Arizona state courts have not ruled on whether Arizona’s constitutional jury trial right applies to state administrative procedures. Most states (including Arizona) include a right to jury trial in their state constitution. See, e.g., A.R.S. Const. Art. 6 § 17. Thus, the reasoning and logic used to support the Jarkesy decision can be similarly applied to state agencies. For example, the Arizona Corporate Commission often brings enforcement actions against individuals and companies for securities fraud and conducts hearings before an administrative law judge. This practice may have to change if Arizona courts find that the right to a jury trial has been violated in these administrative proceedings. 

We will continue to monitor whether state administrative procedures will change in light of the Jarkesy decision and provide you with the latest updates.