Capital Markets, Professional Perspective - How Will the Jarkesy Decision Affect the SEC?
In this article for Bloomberg Law, partners Zachary Brez, Nader Salehi and John Byrnes analyze the Fifth Circuit's opinion in Jarkesy v. SEC, the constitutional issues with the SEC's use of administrative adjudicative proceedings and how this decision will ultimately affect the SEC.
In May 2022, the Fifth Circuit issued an opinion in Jarkesy v. SEC, 34 F.4th 446 (5th Cir. 2024), invalidating an SEC order against hedge fund manager George Jarkesy. The panel found multiple constitutional issues with the SEC's use of administrative adjudicative proceedings, and cast doubt more generally on administrative adjudication by federal agencies. The SEC appealed and the Supreme Court granted certiorari, with oral argument held in November 2023. Court-watchers and the securities bar have followed the matter closely, with some predicting a crippled SEC enforcement program or even the end of the modern federal government as we know it.
While a ruling against the SEC would be an embarrassment for an agency that has dismissed claims like Jarkesy's as fringe and legally unsupportable, the sort of outsized effects on the SEC that some have predicted are unlikely to occur. A ruling against the SEC would have some short-term effects, as the SEC rethinks its processes and fends off challenges to its pending and historical administrative actions.
But as discussed further below, even with the loss or narrowing of the administrative enforcement option, the SEC can continue to accomplish its goals through civil enforcement in federal court. The agency's enforcement program already relies heavily on federal court litigation (and settled actions achieved through the threat of such litigation), and the agency can readily shift most administrative actions to the federal court forum. Perhaps that ostensibly more neutral forum will be less receptive to SEC positions than SEC administrative courts; only time will tell.
However, a balanced analysis will recognize that the enforcement approach of the current SEC leadership does not rely on a single procedural mechanism, and the agency likely will continue to use its enforcement powers aggressively and push for ever high penalties. As to the potential effects of a Jarkesy decision on the rest of administrative state writ large, that is a different matter not addressed here.
Background On SEC Administrative Adjudication
The SEC administrative enforcement process as it operates today is a relatively new development. It is true that the SEC has conducted some administrative adjudications from its founding, and on occasion has announced significant new rules through that process. See, e.g., Cady, Roberts & Co., 40 S.E.C. 907 (1961) (finding that insider trading violates Rule 10b-5). Yet the administrative process was historically limited to entities directly regulated by the SEC—such as broker dealers, investment advisers, and investment companies—and even against these entities, monetary penalties were not available in administrative actions until 1990. Much of the SEC's enforcement activity was necessarily conducted in federal court.
Following the 2008 financial crisis, Congress further expanded the powers of the SEC, passing the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among other things, the Dodd-Frank Act authorized the SEC to bring a full range of cases administratively, with the same types of monetary remedies available in federal court. Pub. L. 111-203 § 929P, 124 Stat. 1853 (July 21, 2010). With this new authority—and a string of high-profile losses in federal court—the SEC began to more frequently use administrative proceedings. This move prompted criticism from industry participants and others, including Judge Jed Rakoff, who raised concerns about the “informality and arguable unfairness of S.E.C. administrative proceedings.” PLI Securities Regulation Institute Keynote Address, Is the SEC Becoming a Law unto Itself? (November 5, 2014).
It also led defendants to bring various constitutional challenges, including the successful challenge in Lucia v. S.E.C., 585 U.S. 237 (2018), which forced the SEC to reappoint its ALJs, and an initially unsuccessful attempt to obtain an injunction in Jarkesy v. SEC, 803 F.3d 9, 12 (D.C. Cir. 2015). Given these headwinds, the SEC continued to use the administrative option, but never fully committed—the number of ALJs, for example, declined to as low as two in 2023, from the five in place at the time of the Lucia decision. See Lucia v. S.E.C., 585 U.S. 237, 241 (2018).
Effects Of An Adverse Ruling On SEC's Enforcement Program
Jarkesy threatens the continued use of administrative adjudication and has potential to disrupt the SEC's current docket of cases and historical administrative rulings. A negative decision could force procedural and forum adjustments by the SEC, including funneling more cases to federal courts (that at least historically were seen by many as less friendly to the SEC than its own ALJs). That said, regardless of the Jarkesy outcome, the SEC will still have various options to bring enforcement actions, including centrally in the federal courts.
Federal Court Litigation Is Already Central To SEC Enforcement Program
First, unlike some other agencies, the SEC already relies heavily on its civil enforcement authorities in federal court. In each of the past five years, the SEC filed at least 200 standalone civil actions in federal court—just about the same as the annual number of standalone administrative actions filed (excluding delinquent filing cases). See SEC Division of Enforcement Annual Reports / Enforcement Statistics, 2018-2023. If it loses the administrative option, the SEC will not have to learn how to litigate in federal court—the SEC already has enforcement attorneys who are veterans of federal court.
If anything, the statistics showing a 50/50 civil/administrative split understate the importance of civil litigation to the SEC's current enforcement program. Of the SEC's significant contested actions, most are brought in federal court. While the enforcement statistics reflect large numbers of administrative actions, most of these are not contested—in other words, they are negotiated settlements that just happen to be styled as an administrative cease-and-desist order. If administrative resolution were not available, these cases could likely have been settled in federal court.
The contrast between the use of administrative and civil proceedings is particularly stark with respect to enforcement actions against public companies. Contested administrative actions involving corporate entities are rare, particularly for non-financial companies not directly regulated by the SEC. Since Lucia, every major contested public company action has been brought in federal court. An adverse decision in Jarkesy might change the form of the settled actions with these companies, but it would not necessarily affect how the contested cases are handled.
SEC Will Continue to Have Advantages Litigating In Federal Court
Second, it is notable that the SEC has a strong win rate in federal court; for example, in 2022 the SEC reported a win rate of 80% at trial, with additional victories at the summary judgment stage. See Press Release 2022-206, SEC Announces Enforcement Results for FY22 (Nov. 15, 2022). While self-reported “wins” and “losses” by litigants can sometimes be a subject of defining what a “win” looks like, the data seem to suggest that the SEC is not experiencing broad defeats in federal court.
Aiding the SEC's win rate is its nationwide subpoena power: as part of Dodd-Frank, Congress granted the SEC the ability to compel the attendance of witnesses nationwide. Pub. L. 111-203 § 929E, 124 Stat. 1853 (July 21, 2010). The SEC already had the broad ability to bring suit in “any such district … wherein the defendant is found or is an inhabitant or transacts business.” 15 U.S.C. § 78aa(a). But the change authorizing nationwide subpoenas freed the SEC to select more friendly jurisdictions—whether in terms of judges or case law—without the constraint of having witnesses nearby.
To be sure, there is evidence that the SEC is more likely to prevail in its administrative proceedings. For example, last year Justice Thomas cited a statistic that “between October 2010 and March 2015, SEC won more than 90% of cases brought before its ALJs as compared to 69% of cases brought before federal courts.” Axon Enter. v. FTC, 598 U.S. 175, 197 n.1 (2023) (Thomas, J., concurring). However, the higher administrative win rate perhaps reflects in part that the SEC's administrative docket includes many simpler cases with clear or even undisputed violations, such as appeals of industry bans.
Whatever the exact win rates in contested matters, most targets of SEC investigations are not inclined to risk litigation—regardless of the forum. The overwhelming majority of SEC enforcement actions are settled, and the loss of the administrative option is unlikely to change that.
Takeaways
In the event of a ruling in Jarkesy against the SEC, it is unclear what relief will redound to targets of SEC investigations. Given the SEC's willingness to litigate in federal court, the loss of the administrative enforcement option will not prevent the SEC from moving forward if it chooses.
It is possible that the SEC will forego certain cases in federal court that it would have brought in administrative courts; or that the SEC will settle cases for lower numbers if federal courts are the only forum available, as opposed to litigating in front of SEC ALJs. Federal court may be more costly and time consuming for the SEC than administrative proceedings, but that is also the case for the defendant—a fact that the SEC may take into account when negotiating. Likewise, jury trials are a risk for the SEC, but defendants accused of financial fraud may also prefer not to leave their fates in the hands of a lay jury.
Indeed, a chastened SEC may double down on its efforts to punish violators and demonstrate results, rather than backing off. As Enforcement Director Gurbir Grewal said at the Securities Enforcement Forum in November 2023, while the agency is “awaiting a ruling from the Supreme Court … we need to hold folks accountable now … And so filing in federal court is an option that's available to us, and we are committed to using every possible tool that we can to hold bad actors in this case, gatekeepers accountable.”
Jarkesy may prove to change the landscape for defendants in SEC enforcement cases. The precise reasoning and outcome of the case will shed light on possible outcomes. The issues are complex, particularly because the effects of a potential adverse decision may be more nuanced than declaring a “winner” or “loser.” If the SEC is forced to litigate before Article III judges, it may change assessments of what cases to bring and/or what price warrants a settlement. It will be interesting to see how these issues play out in the wake of the Supreme Court decision.
