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SEC Power: Supreme Court Limits Agency’s Power to Unilaterally Enforce Financial Fraud Regulations
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The U.S. Supreme Court building stands on June 14, 2024 in Washington, DC.
CNN —
The Supreme Court on Thursday limited the power of the Securities and Exchange Commission to enforce security fraud violations, supporting a hedge fund manager and former conservative radio show host who said he was entitled to a jury trial rather than an internal agency review.
The decision could have huge consequences for the SEC and other agencies, requiring them to prosecute violations in federal court rather than through a more streamlined internal review. That could make it harder to police fraud and protect investors, while also increasing backlogs in federal courts.
Chief Justice John Roberts wrote the decision by a 6-3 majority, with the court’s three liberals dissenting.
The Supreme Court declined to address more existential challenges to the agency’s enforcement structure, including claims that it could have severely hampered the government’s ability to use in-house administrative law judges or shield them from the political whims of a president.
“A defendant facing a fraud lawsuit has the right to be tried by a jury of his peers before a neutral judge,” Roberts wrote. “Rather than recognize this right,” the chief wrote, his dissenting colleagues “would allow Congress to concentrate the functions of prosecutor, judge, and jury in the hands of the executive branch.”
“This is the exact opposite of the separation of powers that the Constitution requires,” he wrote.
A dissent from Justice Sonia Sotomayor, signed by the court’s two other liberals, called Thursday’s decision a “power grab” that “overturns longstanding precedent and the established practice of its co-equal partners in our tripartite system of government.”
She said “important consequences flow from the majority’s insistence that the government’s rights to civil penalties must now be tried by a jury in federal court.”
“Today’s decision is part of a disconcerting trend: When it comes to the separation of powers, this Court is telling the American public and its coordinating branches that it knows best,” Sotomayor wrote, later adding that whether to use an internal agency adjudication system was a policy decision that should be made by Congress.
“Make no mistake: today’s decision is a power grab,” she wrote. “It prescribes artificial constraints on what modern-day adaptive governance should look like.”
But the court’s decision was much narrower than it could have been. The Louisiana appeals court, which also ruled against the SEC, embraced a broader set of arguments that could have made enforcement by multiple agencies more difficult. Instead of dealing with these questions, Roberts focused entirely on the question of whether the Seventh Amendment requires jury trials for the types of actions in question.
George Jarkesy, the hedge fund manager at the center of the dispute, applauded the court’s ruling, saying “the ramifications of this case are much greater than one person.”
“After a decade of gross misconduct and blatantly unconstitutional political attacks by the SEC and its internal court, today the United States Supreme Court ruled that the Constitution still matters,” he said in a statement.
The case, one of several challenging the power of federal agencies in this regard, arose in 2013 when the SEC filed an executive action for securities fraud against Jarkesy, who created two hedge funds that held about $24 million in assets and brought in more than 100 investors.
The agency accused Jarkesy of overvaluing assets to charge higher fees. An administrative law judge — an internal agency official who adjudicates such claims — upheld the charges and ordered Jarkesy to pay a $300,000 civil penalty and disgorge nearly $685,000 in “ill-gotten gains.”
Jarkesy not only challenged the decision, but also the process used to reach it. He claimed the internal procedure violated his 7th Amendment right to a jury trial. He also said the way the agency’s administrative law judges are appointed violates other provisions of the Constitution because the president is prohibited from removing them in most circumstances.
Such protections were put in place in the 1940s to insulate agency law judges from politics and criticism that their procedures were biased in favor of the agencies for which they worked. SEC administrative law judges can only be removed “for cause” by SEC commissioners, who themselves can only be removed for cause.
The SEC is made up of five members appointed by the president and confirmed by the Senate. The commission can enforce a variety of federal statutes in two ways. It may institute administrative enforcement proceedings seeking civil penalties, or it may bring civil actions in federal court.
The 5th U.S. Circuit Court of Appeals sided with Jarkesy on three constitutional claims. It held that certain SEC procedures deprive individuals of their right to a jury trial. It said Congress improperly delegated legislative power to the SEC by giving the agency authority to choose the domestic administrative route rather than a federal court. And it said the way administrative law judges were protected from removal violated constitutional principles of presidential power.
Other agencies use similar internal adjudicators to review fraud allegations, including the Department of Labor and the Social Security Administration.
The SEC case is one of several before the Supreme Court this year that seek to undermine the power of federal agencies. Two cases argued in mid-January challenged agencies’ ability to interpret vague laws when establishing regulations. Another involved the funding mechanism of the Consumer Financial Protection Bureau, an agency created after the 2008 financial crisis.
A 7-2 majority maintained this financing structure on May 16, in an opinion written by Justice Clarence Thomas that represented a significant victory for the Biden administration.
This story has been updated with additional information.