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31 May 20228 minute read

Jarkesy v SEC: Fifth Circuit vacates SEC decision – latest case questioning constitutionality of the ALJ process

On May 18, 2022, the United States Court of Appeals for the Fifth Circuit issued an opinion vacating a decision by the Securities and Exchange Commission (SEC) that George Jarkesy, Jr. and his investment adviser Patriot28, L.L.C. (collectively, the petitioners) had committed securities fraud.

The court held that “(1) Petitioners were deprived of their constitutional right to a jury trial; (2) Congress unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise the delegated power; and (3) statutory removal restrictions on SEC ALJs violate Article II.”  See Jarkesy v. Sec. & Exch. Comm’n, 34 F. 4th 446 (5th Cir. 2022).

This decision is the latest in a series of cases questioning the constitutionality of the SEC’s administrative process and the agency’s use of Administrative Law Judges.


Jarkesy created two hedge funds and appointed Patriot28 as the investment adviser. The funds secured over 100 investors and managed over $20 million in assets. 

In 2011, the SEC launched an investigation into the hedge funds, eventually bringing an administrative action against the petitioners. The SEC alleged that the petitioners had committed securities fraud and sought both monetary and equitable relief. 

Before the trial started, the petitioners sued to enjoin the proceedings, claiming violations of several constitutional rights. The US District Court for the District of Columbia and the US Court of Appeals for the DC Circuit decided that no jurisdiction existed, and the petitioners were required to continue the administrative process and then appeal.

After an evidentiary hearing, an SEC Administrative Law Judge (ALJ) found that the petitioners were liable, and the SEC affirmed. The ALJ and the SEC rejected the petitioners’ constitutional arguments. The Commission ordered that the petitioners cease and desist from committing further violations and that they pay disgorgement and a civil penalty. Additionally, Jarkesy was barred from various industry activities. The petitioners appealed.

The decision

The Fifth Circuit vacated the SEC’s decision and remanded for further proceedings consistent with its opinion. 

The right to a jury trial

As a preliminary matter, the court held that the SEC’s use of an ALJ to adjudicate the claims deprived the petitioners of their Seventh Amendment right to a jury trial because the SEC’s enforcement proceeding was similar to traditional actions at law to which the right to a jury trial attaches. The court noted that while Congress has the power to assign certain proceedings involving public rights to administrative adjudication, eliminating the right to a jury, it cannot assign adjudication of claims that are similar to traditional actions at law to an agency because such claims do not only concern public rights.

Relying on Supreme Court precedent, the Fifth Circuit examined the SEC’s enforcement action using a two-stage analysis: 

  • whether the claims in the action “arise ‘at common law' under the Seventh Amendment” and
  • if so, whether Congress was permitted to assign the claims to agency adjudication without a jury trial.

Key factors in the analysis include whether Congress created a new cause of action and remedies that were previously unknown under common law and whether a jury trial would effectively dismantle the statutory scheme or impede swift resolution of the claims created by the statute. 

In evaluating the SEC’s enforcement action, the Fifth Circuit determined that fraud claims existed under common law and that a civil penalty was a type of remedy under common law that could be enforced in the courts. Consequently, the right to a jury trial applied to the penalties action brought by the SEC against the petitioners. Even though the SEC’s action had equitable components, those components did not invalidate the right to a jury trial that attaches to the civil penalties that the SEC was seeking. 

Further, the court concluded that the SEC’s claims were not the type of claims that could be properly assigned to agency adjudication under the public-rights doctrine.  Securities fraud claims are not new; such claims existed at common law.  In addition, jury trials would not dismantle the statutory scheme or impede swift resolution of such claims.  As the Fifth Circuit pointed out, the statutory scheme allows the SEC to bring claims either administratively or in Article III courts where the right to a jury trial applies.

The court rejected the SEC’s argument that a government enforcement action is automatically transformed into a public rights claim suitable for administrative adjudication. The court explained that, traditionally, securities and fraud claims were resolved in the federal courts. The SEC’s presence as a party did not necessitate an administrative proceeding. The court also noted that “Congress cannot change the nature of a right, thereby circumventing the Seventh Amendment, by simply giving the keys to the SEC to do the vindicating.” 

            Unconstitutional congressional delegation of legislative power

Next, the court held that Congress unconstitutionally delegated legislative power to the SEC when it gave it full discretion to choose whether to bring actions in an Article III court or before an ALJ.


The court explained that the power to determine which cases are decided by an administrative tribunal versus an Article III court is legislative in nature. When Congress delegates such legislative power, it must offer an intelligible principle for exercising such power. Here, the court determined that Congress had “offered no guidance whatsoever” as to that principle. Therefore, the delegation was unconstitutional. 


            Unconstitutional ALJ removal restrictions


Last, the court held that statutory restrictions on the removal of the SEC’s ALJs were unconstitutional. Resolving an issue left open by the Supreme Court in Lucia v. SEC, the Fifth Circuit found that the statutory removal protections provided to SEC ALJs are unconstitutional.


SEC ALJs can only be removed for good cause by the Merits System Protection Board, whose members in turn can only be removed for cause by the president. This two-layer for-cause removal standard has been found unconstitutional by the Supreme Court. Consequently, SEC ALJs, the Fifth Circuit held, are unconstitutionally shielded from removal. 


What’s next?


The Fifth Circuit’s opinion in Jarkesy was issued just two days after the Supreme Court’s May 16, 2022, grant of certiorari in SEC v. Cochran, a case where the Fifth Circuit, sitting en banc, ruled that defendant Michelle Cochran could challenge the constitutionality of the SEC’s ALJs in district court before her case was heard administratively. The DC Circuit Court of Appeals had rejected Jarkesy’s similar challenge. 


The Supreme Court accepted certiorari in Cochran despite the SEC’s request that the lower court delay review of Cochran until it decided a case raising similar issues, Axon Enterprise, Inc. v. FTC.


These cases tee up several important issues for those facing SEC administrative enforcement proceedings:

  • Can constitutional challenges to administrative agency processes be brought in federal court before the conclusion of the administrative hearings?
  • Does congressional delegation to the SEC of the power to decide whether to sue administratively or in an Article III court satisfy constitutional principles?
  • Do the removal restrictions on the SEC’s ALJs violate the Constitution?
  • Does the Constitution permit the SEC to deprive respondents of a jury trial right in cases seeking civil penalties and other claims in which a right to a jury trial is attached at common law?

Notably, the Supreme Court’s decision to accept certiorari in Cochran is not likely to resolve the substantive issues raised in Jarkesy. Cochran will likely only determine whether challenges to the constitutionality of the ALJ removal process may be brought in district courts prior to resolution of the case in the administrative forum. Nonetheless, the decision in Cochran may signal the Supreme Court’s views on the removal arguments and on the insular nature of the SEC’s administrative forum. 


As these issues continue to work their way through the courts, those facing SEC administrative enforcement actions should carefully consider their strategy for preserving these constitutional claims as the cases proceed. In the interim, those facing enforcement actions should expect the SEC to litigate cases in federal court, given the uncertainties surrounding the use of the administrative forum.


Find out more about the implications of these developments by contacting any of the authors or your usual DLA Piper relationship attorney.