The Supreme Court today ruled that the Securities and Exchange Commission (SEC) may not impose civil penalties for fraud without filing suit in federal court. Because "the SEC's antifraud provisions replicate common law fraud," Chief Justice John Roberts writes for the majority in SEC v. Jarkesy, alleged violators are entitled to a jury trial under the Seventh Amendment.
The decision rejects a perverse system in which the SEC, instead of seeking adjudication by an Article III court, can investigate, charge, prosecute, and penalize people for violating securities laws, with only limited judicial review after the fact. In this case, the SEC accused investment adviser George Jarkesy Jr. and his firm, Patriot28, of misrepresenting his investment strategies, "lying about the identity of the funds' auditor and prime broker," and "inflating the funds' claimed value" to boost his management fees. After an in-house process in which the agency confirmed its own allegations, it imposed civil penalties totaling $300,000. Although the SEC had the option of suing Jarkesy for securities violations in federal court, it chose to handle the matter internally.
Roberts notes the implications of that approach. When the SEC files a lawsuit, "a jury finds the facts," "a life-tenured, salary-protected Article III judge presides," and "the litigation is governed by the Federal Rules of Evidence and the ordinary rules of discovery." But when "the SEC adjudicates the matter in-house, there are no juries." Instead the SEC, following its own rules, "presides and finds facts while its Division of Enforcement prosecutes the case."
Such proceedings are overseen by a commissioner or, as in this case, an SEC-employed administrative law judge. Either way, Roberts notes, the full commission can review the resulting "findings and conclusions," but "it is not obligated to do so." And while independent judicial review is available "once the proceedings have concluded," it is "deferential": The court "must treat the agency's factual findings as 'conclusive' if sufficiently supported by the record, even when they rest on evidence that could not have been admitted in federal court."
Although that approach was authorized by the Dodd-Frank Act of 2010, Jarkesy argued that it violated the Seventh Amendment, which says "the right of trial by jury shall be preserved" in "suits at common law" where "the value in controversy shall exceed twenty dollars." Six justices agreed.
"This case poses a straightforward question: whether the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties against him for securities fraud," Roberts writes. "The threshold issue is whether this action implicates the Seventh Amendment. It does. The SEC's antifraud provisions replicate common law fraud, and it is well established that common law claims must be heard by a jury."
That outcome, Roberts says, is dictated by the Court's 1987 decision in Tull v. United States and its 1989 decision in Granfinanciera, S. A. v. Nordberg. In Tull, the Court held that the Seventh Amendment guarantees the right to a jury trial to determine liability when the government seeks civil penalties and injunctive relief under the Clean Water Act. In Granfinanciera, the Court upheld that right in a case where a bankruptcy trustee sued to recover money from an allegedly improper transfer.
Under those decisions, statutory claims that are "legal in nature" implicate the Seventh Amendment. A civil penalty falls into that category when "the cause of action resembles common law causes of action" and " the remedy is the sort that was traditionally obtained in a court of law." In this case, Roberts says, "the remedy is all but dispositive."
For Jankesy's alleged fraud, Roberts notes, the SEC "seeks civil penalties, a form of monetary relief." Such relief is "legal in nature" when "it is designed to punish or deter the wrongdoer" rather than "solely to 'restore the status quo.'" SEC penalties are based on factors such as "culpability, deterrence, and recidivism," which "are legal rather than equitable." They are "a type of remedy at common law that could only be enforced in courts of law."
That conclusion, Roberts says, is confirmed by "the close relationship between federal securities fraud and common law fraud." Both "target the same basic conduct: misrepresenting or concealing material facts." By using "fraud" and "other common law terms of art," Congress "incorporated prohibitions from common law fraud into federal securities law."
The SEC argued that the Seventh Amendment did not apply in this case because the agency was seeking to vindicate "public rights"—an argument endorsed by the three dissenting justices: Sonia Sotomayor, Elena Kagan, and Ketanji Brown Jackson. But Roberts says that exception "does not apply here because the present action does not fall within any of the distinctive areas involving governmental prerogatives," such as revenue collection, immigration control, tariffs, "relations with Indian tribes," and the granting of public benefits, where "the Court has concluded that a matter may be resolved outside of an Article III court, without a jury."
In a concurring opinion, Justice Neil Gorsuch, joined by Justice Clarence Thomas, highlights two other issues raised by this case: the powers of federal courts under Article III and the right to due process under the Fifth Amendment. "The SEC's in-house civil-penalty scheme violates Article III," Gorsuch says, by withdrawing a matter traditionally handled by common-law courts "from judicial cognizance" and "handing it over to the Executive Branch for an in-house trial." And in cases like this, he says, due process "means the regular course of trial proceedings with their usual protections" rather than "the use of ad hoc adjudication procedures before the same agency responsible for prosecuting the law, subject only to hands-off judicial review."
The allegations against Jarkesy, Gorsuch emphasizes, "should not obscure what is at
stake in his case or others like it." He concedes that "people like Mr. Jarkesy may be unpopular" and "perhaps even rightly so," given that "the acts he allegedly committed may warrant serious sanctions." But "while incursions on old rights may begin in cases against the unpopular," he says, "they rarely end there."
The SEC, Gorsuch notes, wants to "penalize citizens without a jury, without an independent judge, and under procedures foreign to our courts." That approach, he says, violates constitutional constraints that "ensure even the least popular among us has an independent judge and a jury of his peers resolve his case under procedures designed to ensure a fair trial in a fair forum."
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