The Lawletter Vol. 49 No. 3
Paul Ferrer, Senior Attorney
SECURITIES LAW/CIVIL PROCEDURE: Supreme Court Rules That Jury Trial Is Required When SEC Seeks Civil Penalties for Securities Fraud
The United States Supreme Court has limited one of the U.S. Securities and Exchange Commission’s (SEC’s) major tools for penalizing securities fraud by ruling that the Seventh Amendment requires a jury trial when the SEC seeks civil penalties against a defendant. See SEC v. Jarkesy, 144 S. Ct. 2117 (2024). And the decision may have much more far-reaching implications by calling into question the ability of other government agencies to seek civil penalties.
Three of the primary federal statutes regulating the registration and trading of securities—the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940—all contain antifraud provisions that target the same basic behavior: misrepresenting or concealing facts that would be material to an investor’s decision. These statutes are enforced by the SEC, which may bring an enforcement action either (1) in its own forum, an administrative proceeding, or (2) in a federal court action. In federal court, a federal judge presides, a jury decides the facts, proceedings are governed by the Federal Rules of Evidence, and discovery is had under the Federal Rules of Civil Procedure. By contrast, when the SEC adjudicates the matter in-house, its Division of Enforcement prosecutes the case and the SEC presides and finds the facts, although the SEC may delegate its role as judge and fact finder to one of its administrative law judges (ALJs). The SEC or its ALJ decides discovery disputes and determines the scope and form of permissible evidence pursuant to the SEC’s own Rules of Practice. The SEC can, but does not have to, review the ALJ’s findings and conclusions. Judicial review is available but is deferential.
One of the SEC’s most potent antifraud enforcement tools is civil penalties, which consist of fines of up to $725,000 per violation, even when no investor has actually suffered a financial loss. Historically, the SEC could seek civil remedies against a defendant accused of securities fraud only in federal court. But in 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which authorizes the SEC to seek civil penalties in its own in-house proceedings as well as in federal court.
That is what happened in the Jarkesy case, in which the SEC found that Jarkesy and his advisory firm had misled investors in three ways and levied a civil penalty of $300,000, among other remedies, against them. Jarkesy challenged the penalty, arguing that the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties for securities fraud. The Supreme Court agreed.
Chief Justice Roberts wrote the opinion for the Court in a 6-3 decision. Chief Justice Roberts found it a simple matter to conclude that the Seventh Amendment—which guarantees that in “[s]uits at common law, … the right of trial by jury shall be preserved”—was implicated. He reasoned that the Seventh Amendment extends to a statutory claim that is legal in nature, and monetary relief, such as a civil penalty, is “the prototypical common law remedy.” 144 S. Ct. at 2129.
Chief Justice Roberts and the dissenters split over whether the “public rights” exception should apply. Under this exception, when Congress creates a “public right,” it can “assign the matter for decision to an agency without a jury, consistent with the Seventh Amendment.” Id. at 2131. On the other hand, adjudication by an Article III court is mandatory for matters concerning private rights, which presumptively include a suit in the nature of an action at common law. Chief Justice Roberts conceded that the Court’s opinions governing the public-rights exception “have not always spoken in precise terms,” and he declined to offer a definitive explanation of the distinction between public and private rights in Jarkesy. Id. at 2133. Even so, Chief Justice Roberts opined that “what matters is the substance of the suit, not where it is brought, who brings it, or how it is labeled.” Id. at 2136. As such, Chief Justice Roberts disagreed with the dissenters that the fact that the action was commenced by the United States was sufficient to trigger the public-rights exception. Rather, because a securities-fraud action is, in substance, in the nature of a common-law suit for fraud, the action concerns a private right and the defendant “has the right to be tried by a jury of his peers before a neutral adjudicator.” Id. at 2139.
In her dissenting opinion, Justice Sotomayor, joined by Justices Kagan and Jackson, recognized the practical impact the majority’s decision could have on the administrative state, given that more than two dozen agencies can impose civil penalties, and often only in administrative proceedings, which could effectively strip those agencies “of their power to enforce laws enacted by Congress,” since they currently have no authority to proceed in court. Id. at 2173-74. Justice Sotomayor noted that agencies regulating public welfare that fall into that boat include the Occupational Safety and Health Review Commission, the Federal Energy Regulatory Commission, the Federal Mine Safety and Health Review Commission, and the Department of Agriculture. Id. at 2174.