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Historically, the SEC could only bring enforcement actions in Article III courts.1 That began to change in 1990 with the Securities Enforcement Remedies and Penny Stock Reform Act, which allowed the agency to bring certain actions in administrative tribunals.2 The Dodd-Frank Act of 2010 gave the SEC the full ability to use administrative tribunals; by the middle of the 2010s the use of administrative tribunals had sharply risen.3 Recently, several cases have called into question the constitutionality of such tribunals. This alert will focus on two of those cases, Cochran v. SEC and Jarkesy v. SEC—both decided by the United States Court of Appeals for the Fifth Circuit (“Fifth Circuit”)4—as well as what those cases portend for future SEC enforcements and the executive branch at large.
First, in Cochran v. SEC, an SEC administrative law judge (“ALJ”) imposed a $22,500 fine and a 5-year ban on practicing before the SEC on Michelle Cochran, a CPA.5 Cochran then objected to that penalty.6 In the meantime, Lucia v. SEC was adjudicated. That case focused on the issue of the unconstitutional appointment of SEC ALJs, as opposed to the issue of their removal, which is the focus of Cochran. In Lucia it was determined that not all SEC ALJs, who are “inferior officers” and per Article II of the Constitution should therefore be appointed by the President, a court of law, or a department head, were constitutionally appointed—rather, they were sometimes appointed by SEC staff.7 Due to Lucia, the SEC was going to remand all administrative proceedings to new, constitutionally-appointed ALJs, including Cochran’s proceeding.8 Before doing so, Cochran appealed to federal district court, claiming that although Lucia resolved the appointment issue, it did not resolve the issue of removability.9 Namely, ALJs could only be removed through a two-tier “for-cause” dismissal system, which insulated them from Congressional impeachment under the Constitution.10 The district court dismissed the case due to a lack of subject matter jurisdiction.11 Cochran then appealed to the Fifth Circuit.12 A panel of the Fifth Circuit initially affirmed the dismissal, however, the court granted a rehearing en banc, wherein it reversed the decision of the district court in part, as to jurisdiction.13 The SEC filed a petition for a writ of certiorari which was granted on May 16, 2022.14
Next, in SEC v. Jarkesy, the SEC launched an investigation into George Jarkesy’s hedge fund operations.15 The SEC then decided to bring a proceeding against him in an SEC administrative tribunal.16 Before the proceeding began, Jarkesy sought to have the proceeding enjoined in the United States District Court of the District of Columbia (and then in the U.S. Court of Appeals for the D.C. Circuit) but both courts decided that there was no jurisdiction to hear the claim prior to the conclusion of the administrative process.17 The courts held that per §78(y) of the Securities Exchange Act of 1934, Jarkesy could appeal to a federal court only once he had received a final order from the SEC, and the SEC could only review the case upon appeal from an SEC administrative judge’s decision.18
Jarkesy therefore continued his SEC ALJ proceeding. The ALJ conducted an evidentiary hearing and found him guilty of securities fraud.19 Jarkesy appealed the ALJ’s decision, and upon review of the decision, the SEC agreed with the ALJ and ordered a $300,000 civil penalty, a $685,000 disgorgement penalty, and a ban on various securities activities.20 Following this decision, Jarkesy appealed to the Fifth Circuit.21 The Fifth Circuit vacated the SEC’s decision against Jarkesy and remanded the matter. It found that this action, at least as to the civil penalty, was akin to an action at law that afforded Jarkesy a right to a jury trial, while the equitable parts of the proceeding could be brought in a non-jury administrative proceeding.22 The Fifth Circuit also ruled that Congress had improperly delegated legislative power to the SEC.23 The Dodd-Frank Act of 2010 delegated to the SEC the authority to decide whether to bring disputes in Article III courts or in administrative proceedings.24 According to the Fifth Circuit, that power is legislative because it affects the legal processes under which the defendant’s case will be governed.25 According to Supreme Court precedent, legislative power may be delegated only if it is accompanied by an “intelligible principle” by which it will be applied.26 In this case no such principle was provided; instead, it is completely up to the SEC’s discretion whether it will assign a dispute to an Article III court or to an administrative proceeding. Lastly, the Fifth Circuit ruled that the two-layer “for-cause” removal system in place for SEC ALJs precludes the President from the exercise of the oversight powers granted under the Take Care Clause of the U.S. Constitution.27
The above two cases have several important implications. First, in Axon Enterprise v. Federal Trade Commission, a body camera manufacturer sought in district court to enjoin an FTC administrative proceeding that aimed to break up its alleged monopoly on the body camera industry.28 Axon argued, like in Cochran, that FTC administrative proceedings are unconstitutional in part because FTC ALJs are insulated from Article II removal power.29 The District Court of Arizona found, and the U.S. Court of Appeals for the Ninth Circuit affirmed, that the FTC Act precluded the district court’s jurisdiction of such constitutional questions.30 The Axon case was granted certiorari on January 24, 2022.31 Furthermore, the government asked to consolidate the briefings for Cochran and Axon Enterprise, and the Supreme Court granted its motion32. Given the Supreme Court’s willingness to grant certiorari on both administrative law cases, it seems likely that it will come down with a decision that has widespread implications for the executive branch.
Secondly, many SEC proceedings are resolved by settlement.33 Given the holdings of the above cases, we may now see many of those who received a less-than-favorable settlement from the SEC appeal their cases on the grounds that they were unconstitutionally denied a jury trial, or that the ALJs who adjudicated their cases were unconstitutionally appointed or insulated from removal.
Thirdly, the holdings in Jarkesy, namely that the SEC has improperly been delegated legislative power, and that at times respondents should have the right to a jury trial, may put pressure on the legislative branch to pass relevant legislation. It would seem logical for Congress to pass a law that provides the SEC with an intelligible principle in guiding the proper venue for its enforcement actions.
In sum, the SEC and other administrative agencies have recently come under increased scrutiny from higher federal courts. Due to that, it appears that ALJ selection and removal criteria will have to be modified, and that Congress will have to provide additional guidance as to how the SEC and other agencies select the venue for disputes that arise.
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- Stebbins et al., The Jarkesy Decision and Ramifications for Administrative Proceedings, Harvard Law School Forum on Corporate Governance, https://corpgov.law.harvard.edu/2022/06/29/the-jarkesy-decision-and-ramifications-for-administrative-proceedings/#8b.
- Id.
- Id.
- Cochran v. SEC, 20 F.4th 194 (5th Cir. 2021); Jarkesy v. SEC, 34 F.4th 446 (5th Cir. 2022).
- Cochran v. SEC, 20 F.4th 194, 198 (5th Cir. 2021).
- Id.
- Id. at 198.
- Id.
- Id.
- Id.
- Id.
- Id.
- Id. at 213.
- SEC v. Cochran, 142 S. Ct. 2707 (Mem) (2022).
- Jarkesy v. SEC, 34 F.4th 446, 450 (5th Cir. 2022).
- Id.
- Id.
- Jarkesy v. SEC, 48 F.Supp.3d 32, 37 (D.D.C. 2014), affirmed by Jarkesy v. SEC, 803 F.3d 9 (D.C. Cir. 2015).
- Id. at 450.
- Id.
- Id.
- Id. at 454-55.
- Id. at 459.
- Stebbins et al., The Jarkesy Decision and Ramifications for Administrative Proceedings, Harvard Law School Forum on Corporate Governance, https://corpgov.law.harvard.edu/2022/06/29/the-jarkesy-decision-and-ramifications-for-administrative-proceedings/#8b.
- Id. at 461.
- Id. at 460-61.
- Id. at 463-64.
- Axon Enterprise Inc. v. FTC, 986 F.3d 1173, 1177 (9th Cir. 2021).
- Id. at 1177.
- Axon Enterprise Inc. v. FTC, 452 F.Supp.3d 882, 886 (D.Az. 2020); Axon Enterprise Inc. v. FTC, 986 F.3d 1173, 1187 (9th Cir. 2021).
- Axon Enterprise Inc. v. FTC, 142 S.Ct. 895 (Mem) (2022).
- Jennifer Bennett, High Court Urged to Allow SEC Judge Challenges in District Court, Bloomberg Law (July 1, 2022), https://news.bloomberglaw.com/us-law-week/high-court-urged-to-allow-sec-judge-challenges-in-district-court.
- Securities Exchange Commission, How Investigations Work, https://www.sec.gov/enforce/how-investigations-work.html (last modified Jan. 27, 2017).
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