Justices’ Questions Signal Narrow Ruling on In-House Judges Case

The US Supreme Court during oral argument Wednesday focused on one part of a triple-headed constitutional challenge to federal agency enforcement, signaling it won’t broadly roll back regulators’ power through its potential ruling focused on SEC in-house judges.

At issue before the justices is a US Court of Appeals for the Fifth Circuit opinion that threw out a ruling by the Securities and Exchange Commission against hedge fund manager George Jarkesy. The appeals court called into question agency enforcement via administrative proceedings, finding three separate constitutional flaws with the SEC’s ability to choose where it brings enforcement proceedings, in-house judges’ removal protections, and the imposition of civil penalties without a jury trial.

The justices’ questions on Wednesday centered on in-house enforcement actions that could trigger the right to a jury trial.

Lawyers told Bloomberg Law ahead of the oral argument that a ruling that upheld all three parts of the Fifth Circuit’s decision could disrupt the use of in-house judges at multiple agencies across the federal government. That outcome would likely result in new streams of cases clogging federal court and crippled enforcement at agencies that can’t go directly to court, they said.

Agencies including the Federal Trade Commission, the Department of Labor, and the National Labor Relations Board also use ALJs for a range of adjudication functions.

But the argument’s focus on the Seventh Amendment right to jury trial and how that relates to securities fraud cases signals that the court could rule narrowly, said Peggy Little, an attorney with the New Civil Liberties Alliance, which filed an amicus brief in support of Jarkesy.

“Fraud is particularly the purview of the SEC. The EPA doesn’t go after people for fraud, nor do most agencies I can think of,” Little said. So “the scope of the ruling could be pretty narrowly circumscribed in a decision,” and “the thought that this is going to have some cataclysmic effect across agencies is overblown,” she said.

SEC’s Enforcement Choices

The Fifth Circuit targeted the SEC’s authority to pick between bringing enforcement actions in administrative or judicial proceedings, holding that Congress unconstitutionally delegated its power by giving the agency that choice. And it took issue with the SEC’s administrative adjudication system because the agency’s judges enjoy a dual layer of protection against being removed from office.

Although a ruling focused on all three prongs of Jarkesy v. Securities and Exchange Commission could have greatly expanded the potential impact on agency enforcement, the questioning from conservative justices including Neil Gorsuch revealed the Supreme Court’s more narrow focus on the interplay between the right to a jury trial and cases brought in administrative proceedings.

“It was just mostly about the Seventh Amendment issue,” said Emily Garnett, partner at Brownstein Hyatt Farber Schreck LLP. “I would wager that the majority issues an opinion written by Gorsuch, since he seems to be the one that has the clearest articulated position on this, finding that as a narrow issue if the SEC is bringing a charge under the ’33 or ’34 Act seeking penalties, they have to do it in district court.”

The Supreme Court previously rejected a Seventh Amendment challenge to administrative enforcement in its 1977 decision, Atlas Roofing Co. v. Occupational Safety and Health Review Commission. Congress can assign fact-finding and initial adjudication to an administrative forum for cases when the government sues to enforce public rights created by federal laws, the court ruled.

Securities Fraud Differs

The Fifth Circuit in Jarkesy distinguished between the public-rights disputes that Atlas Roofing authorized for administrative adjudication and securities fraud charges, which it said were akin to common-law fraud claims and trigger the right to a jury trial.

Sidney Michael McColloch, the attorney for Jarkesy, told the Supreme Court on Wednesday that there’s a long tradition of administrative adjudication for issues like immigration and customs. But securities fraud is different, he said, because it’s analogous to common-law fraud cases going back to the 1700s.

“It was presented as something where they didn’t have to overturn Atlas Roofing, but I think they basically do,” said Hamish Hume, partner at Boies Schiller Flexner. “They could call for additional briefing on that and ask them to pay special attention to impact on how our existing system works and how much we are going to unsettle expectations and the orderly administration of our system of government.”

Agencies focused on consumer regulation like the Federal Trade Commission could still be impacted by a bright-line rule or even a specific ruling on civil penalties derived from fraud allegations, but both types of decisions could leave the door open for potential constitutional challenges going forward, he said.

The case is Securities and Exchange Commission v. Jarkesy, U.S., No. 22-859, oral argument 11/29/23.