The Impact Of Jarkesy: The Right To A Jury Trial At What Cost? 

By Jonathan Carelli (2024 Summer Associate) and Kevin McCabe (2024 Summer Associate)

Recently, the Supreme Court of the United States issued its decision in Securities and Exchange Commission v. Jarkesy, which changed the function of the SEC and potentially other federal agencies, limiting the SEC’s ability to levy civil penalties against private citizens and corporations. This article will discuss the background of Jarkesy, the history of SEC enforcement actions, and analyze the decision itself, along with the potential future impacts on interested parties. 

FACTUAL BACKGROUND

George Jarkesy, Jr. is the manager of Patriot28 (collectively “Jarkesy”), an investment advisor and general partner to two hedge funds. On March 22, 2013, the Securities and Exchange Commission (“SEC”) instituted an enforcement action against Jarkesy and two other defendants, alleging numerous violations of SEC Acts. Pursuant to its enforcement authority from the Dodd-Frank Act, the SEC adjudicated the matter itself, issuing an initial decision in 2014 and a subsequent final order in 2020. On appeal, the Fifth Circuit vacated the final order, holding that the SEC’s decision to adjudicate the matter was a violation of Jarkesy’s Seventh Amendment rights, the non-delegation doctrine of the Constitution, and Executive branch removal powers. The Supreme Court of the United States granted certiorari after the Fifth Circuit denied rehearing en banc.

HISTORY OF SEC ENFORCEMENT ACTIONS AND STATISTICS

Congress created the SEC to enforce the various securities laws it passed in the aftermath of the Wall Street Crash of 1929.  The SEC may choose to pursue actions against alleged wrongdoers in two forums: (1) an in-house adjudication presided over by one the SEC’s administrative law judges (“ALJ”); or (2) file an action for injunction or prosecution in federal district court.” Prior to the passage of the Dodd-Frank Act, the SEC was required to pursue all of its claims for monetary penalties in federal court. The 2010 Dodd-Frank Act made it so that, “the SEC’s authority in administrative penalty proceedings coextensive with its authority to seek penalties in Federal court;” simply meaning that the SEC post Dood-Frank could enforce its own civil penalties through its ALJ proceedings. Proceedings occurring in-house differ procedurally from those brought in federal court. In federal court, the finding of facts is done by a jury, an Article III judge presides, and the litigation is governed by the Federal Rules of Evidence and the ordinary rules of discovery. Whereas when the SEC pursued action in-house, there are no juries and no Article III judges, and the Commission may delegate its role as judge and factfinder to one of its members or to an administrative law judge (ALJ) that it employs. Further, in in-house proceedings, the SEC’s Rules of Practice govern, and the Commission determines the scope and form of permissible evidence. As such, hearsay and other testimony that would be inadmissible in federal court may be admitted in in-house proceedings.

Since the passage of the Dodd-Frank Act, the SEC has pursued enforcement actions pursuant to In 2018, the SEC filed 821 enforcement actions, an increase from the 754 actions filed in the previous fiscal year, netting $754 million in monies distributed to harmed investors and nearly four 2019 saw an increase in enforcement actions, to 862, with corresponding increases to both monies distributed to investors and disgorgement and penalty amounts, at 4.2 billion dollars and nearly 1.2 billion dollars The COVID pandemic reduced the total number of enforcement actions to 715 in 2020, but the SEC was able to reach a new high for monies from disgorgement and penalties, at nearly $4.7 billion, while suffering a significant reduction in monies distributed to harmed investors, at $602 million. Fiscal year 2021 saw a further decreases in enforcement actions down to 697, along with a decrease in both monies distributed to harmed investors and monies from disgorgement and penalties, at $521 million and $3.8 billion, respectively. The Enforcement Division was able to rebound with a strong 2022, instigating 760 enforcement actions, netting $6.4 billion in monies from disgorgement and penalties The SEC continued to increase filings in 2023, with 784 actions instituted, while suffering minor decreases in monies returned to harmed investors at $930 million, and more significant decreases in monies from penalties and disgorgements, at $4.9 billion.

The difference between forums has produced stark contrasts in outcome for defendants of SEC enforcement actions. In his concurring opinion, Justice Gorsich noted the higher rates of success for the SEC in administrative hearings as opposed to trials before article III judges. According to Justice Gorsich, the SEC prevailed in 90% of its contested in-house hearings whereas, it only succeeded in 69% of the cases it brought in federal court.

CASE ANALYSIS

On June 27^th, 2024, the Supreme Court held in SEC v. Jarkesy that the Seventh Amendment prohibits the SEC from bringing enforcement actions for securities fraud before its in-house administrative law judges. In a 6-3 opinion, the Court held that the Seventh Amendment requires that any action seeking civil penalties must be tried before a jury in federal court.

The Court opined that the Seventh Amendment applies to claims created by a federal statute when they are “legal in nature,” meaning that both the cause of action replicates one that was understood at common law and that the remedy provided is one traditionally obtained in a court of law. The Court reasoned that because (1) securities fraud targets the same conduct prohibited by common law fraud, and (2) civil penalties, including money damages, are designed to deter wrongdoers and not to be returned to the victims of the targeted misconduct, securities fraud claims, like those at issue in the case, are subject to the protections of the Seventh Amendment.

The Court also rejected the applicability of the “Public Rights” exception to the Seventh Amendment. The Public Rights exception allows Congress to empower agency decision making power, rather than juries, when such actions historically could have been decided exclusively by the executive or legislative branches.

POTENTIAL IMPACT TO INSURERS AND INSUREDS

While the Jarkesy decision immediately impacts the SEC’s ability to obtain civil penalties, it will likely also have broader implications for a host of federal agencies and may change the way professionals should prepare to face future enforcement actions. Several other administrative agencies, including the Environmental Protection Agency, Office of Foreign Assets Control, and Federal Energy Regulatory Commission, inter alia, rely on civil-penalty enforcement schemes, like that of the SEC. Thus, they are also likely to be required to bring such enforcement actions in federal court. Moreover, it is likely that future litigants will argue to extend the Jarkesy Court’s reasoning to challenge other agency actions using other common law analogues. There are indications that such efforts are already underway, efforts that will likely be successful with the current jurists on the highest court in the land. 

The SEC has reduced its reliance on administrative proceedings in recent years, but the agency has made it clear that civil penalties are an important part of the SEC’s enforcement program. SEC Enforcement Director Gurbir Grewal said in October of 2023 that the SEC would not hesitate to file charges in District Court if the Supreme Court decided against the agency in this case. Now faced with the Jarkesy decision, enforcement actions will continue, albeit in an altered landscape. Professionals should be prepared to face such enforcement action in federal court which can often entail slower proceedings due to higher evidentiary standards, leading to longer cases. However, such a change may prove to be beneficial to professionals facing future SEC enforcement actions, as the SEC wins nine times out of ten when it has home field advantage.

Although defendants/insureds will now proceed in a more favorable trial setting, the costs of such actions are likely to increase for both the SEC and defendants – and insurers. For the SEC, it lacks the resources to pursue charges in District Court against the nearly 1,000 actions filed each year. This may lead to the SEC becoming more selective with their actions, i.e. fewer actions filed against gatekeepers such as accountants and auditors, with a focus turning to the actual wrongdoers. Individuals and firms might also be more bullish about their odds of beating an enforcement proceeding, electing to litigate the case rather than accept a settlement; in any event, the SEC seems poised to lose leverage in its negotiations with potential defendants. However, even while Jarkesy was still pending and most legal experts were predicting this outcome, the SEC continued to bang the drum about the importance of gatekeepers, suggesting that their main directive and focus will be unchanged by the decision. Either way, the cost of such actions will likely increase, at least in the short term, and potentially in the long-term. Professional Liability insurers of firms that work with the SEC and other federal agencies should take note.  

¹ Jarkesy v. S.E.C., 803 F.3d 9, 13 (D.C. Cir. 2015).

² Id. (“The SEC alleged that they engaged in fraudulent conduct in connection with the offer, purchase, and sale of securities, and charged them with violations of the Exchange Act, the Securities Act, the Advisors Act, and the Company Act.”)

³ SEC v. Jarkesy, 603 U.S. 1, 5 (2024).

⁴ Id. at 5-6.

⁵ Id. at 6.

⁶ See SEC v. Jarkesy, 603 U.S. at 2-3.

⁷ 15 USC § 77h-1; 15 USC § 77t

⁸ See Jarkesy, 603 U.S. at 3-4.

⁹ See id.

¹⁰ See Jarkesy, 603 U.S. at 3. 

¹¹ See id.

¹² See id.

¹³See id.

¹⁴ See generally 15 USCA § 78u; 15 USCA § 78u-2; 15 USCA § 78u-3.

¹⁵ U.S. Securities and Exchange Commission, Annual Report Division of Enforcement (2018).

¹⁶ U.S. Securities and Exchange Commission, Annual Report Division of Enforcement (2019).

¹⁷ U.S. Securities and Exchange Commission, Annual Report Division of Enforcement (2021).

¹⁸ U.S. Securities and Exchange Commission, Annual Report Division of Enforcement (2022).

¹⁹ SEC v. Jarkesy, 603 U.S. 1, 3 (2024) (concurring, N. Gorsich).

²⁰ SEC v. Jarkesy, 603 U.S. 1, 3 (2024) (concurring, N. Gorsich).

²¹ SEC v. Jarkesy, 603 U.S. 1, 27 (2024).

²² SEC v. Jarkesy, 603 U.S. 1, 27 (2024).

²³ SEC v. Jarkesy, 603 U.S. 1, 13 (2024).

²⁴ SEC v. Jarkesy, 603 U.S. 1, 8-13 (2024).

²⁵ SEC v. Jarkesy, 603 U.S. 1, 17-26 (2024).

²⁶ SEC v. Jarkesy, 603 U.S. 1, 15 (2024).

²⁷ Michael Brinbaum, Gerardo Gomez Galvis, Jocelyn Edith Greer, Haimavathi Marlier, Craig Martin, Laura Linda Miller, The End of SEC Administrative Proceedings? The Supreme Court’s Jarkesy Decision Prohibits the Agency’s Use of ALJs in Enforcement Actions Seeking Civil Penalties, Morrison & Foerster LLP, (Jul. 1 2024) https://www.jdsupra.com/legalnews/the-end-of-sec-administrative-6028831/.

²⁸ See Gurbir S. Grewal, Remarks At New York City Bar Association Compliance Institute, U.S. Securities and Exchange Commission, (Oct. 24 2023) https://www.sec.gov/newsroom/speeches-statements/grewal-remarks-nyc-bar-association-compliance-institute-102423

²⁹ See Gurbir S. Grewal, Remarks At New York City Bar Association Compliance Institute, U.S. Securities and Exchange Commission, (Oct. 24 2023) https://www.sec.gov/newsroom/speeches-statements/grewal-remarks-nyc-bar-association-compliance-institute-102423

³⁰ SEC v. Jarkesy, 603 U.S. 1, 3 (2024) (Gorsuch, Concurring).

³¹ SEC.gov | Fostering a Healthy “Tone at the Top” at Audit Firms