On June 27, 2024 the US Supreme Court held in SEC vs Jarkesy that the SEC must bring an action in federal court whenever it seeks a civil penalty in connection with a claim of securities fraud. Congress had authorized the SEC to obtain civil penalties through litigation brought either in federal court or before the agency’s own in-house tribunals. But the court concluded that the Seventh Amendment affords defendants in such matters the right to a jury trial before a federal court. The opinion contains several key takeaways for general counsel to discuss with their board.
In 2013, the SEC initiated an in-house proceeding alleging that George Jarkesy and his advisory firm, Patriot28, committed securities fraud. The following year an SEC administrative law judge levied a $300,000 penalty against Jarkesy and Patriot28. Jarkesy and Patriot28 appealed. The US Court of Appeals for the Fifth Circuit vacated the administrative law judge’s order and held that the SEC’s decision to pursue a fraud-based penalty in an administrative proceeding – instead of in federal court – violated Jarkesy’s and Patriot28’s Seventh Amendment right to a jury trial. The SEC appealed to the Supreme Court.
The Supreme Court ruled against the commission and affirmed the Fifth Circuit ruling. According to the Supreme Court, when the SEC seeks penalties for securities fraud, the defendant has a right to a jury trial before a federal court. The court reasoned that the statutes authorizing the SEC to seek penalties tie the availability of penalties to the perceived need to punish a defendant. In such circumstances, defendants are entitled to the protections of the Seventh Amendment.
Five key takeaways
The Supreme Court’s opinion in Jarkesy has a significant, immediate effect on the way the SEC enforces the anti-fraud provisions of the federal securities laws. It will also likely affect the enforcement efforts of other federal agencies. Below are five key takeaways all general counsel should discuss with their board.
- After Jarkesy, the SEC cannot seek fraud-based penalties in administrative proceedings
The main holding of Jarkesy is that whenever the SEC seeks a penalty for a fraud-based securities law violation it must pursue that penalty in federal court, not in the agency’s in-house administrative forum. The ruling is a blow to the SEC’s enforcement program because it eliminates a favorable forum for the agency to obtain penalties against companies and individuals.
- Jarkesy enhances defendants’ leverage in settlement negotiations with the SEC
Defendants in SEC in-house proceedings have fewer procedural protections than in federal court. For example, administrative law judges often decline to issue subpoenas on defendants’ behalf, defendants are limited to five depositions and the Federal Rules of Evidence do not apply. In addition, administrative law judges who preside over the proceedings are employees of the SEC.
Unsurprisingly, the commission has been more successful in administrative proceedings than in federal court. A 2017 study found that when the SEC shifted to bringing more cases in administrative proceedings the agency enjoyed increased leverage in settlement negotiations.
The Jarkesy ruling has changed the negotiation dynamic. Now, whenever the SEC seeks a fraud-based penalty, it must do so in federal court where defendants will have the procedural protections of the Federal Rules of Civil Procedure, the Federal Rules of Evidence, a neutral judge and a jury. Faced with a less favorable forum, the SEC may offer defendants more favorable settlement terms. But federal court litigation tends to take longer and be more expensive for both sides, which also affects the settlement calculus.
- Defendants who choose to litigate with the SEC in federal court should be aware of the potential for negative publicity
SEC administrative proceedings that were litigated largely outside of public view before the Jarkesy ruling will now be litigated publicly in federal court. Administrative proceedings tend to draw less public attention and, unlike the PACER system used by federal courts, the SEC provides only contemporaneous public access to ‘the principal pleadings, orders and decisions’ in an administrative proceeding. The public will have access to all the federal court proceedings, which may result in more negative publicity than an administrative proceeding.
- The SEC will likely continue to seek fraud-based penalties in settled actions filed in administrative proceedings
The commission will likely continue seeking fraud-based penalties in administrative proceedings as long as the defendant consents to the administrative forum as part of a settlement. We are aware of instances, post-Jarkesy, in which the agency has asked defendants to consent to the administrative forum and to waive their rights to litigate in federal district court or raise constitutional challenges.
Agreeing to a settlement in an administrative proceeding could be beneficial to the SEC and the defendant by eliminating the risk that a federal court will reject the settlement.
- Jarkesy could have far-reaching effects
In a dissenting opinion in Jarkesy, Justice Sonia Sotomayor warned that the court’s decision was ‘earth-shattering’ and will have ‘momentous consequences’. She indicated that there are ‘more than two dozen agencies that can impose civil penalties in administrative proceedings’ and that Jarkesy casts doubt on their authority to do so. She also suggested that the reasoning in the court’s majority opinion may not be confined to penalty suits for fraud.
We expect that entities and individuals who are subject to enforcement actions by federal agencies likely will rely on Jarkesy to challenge:
- The authority of such agencies – including the Commodity Futures Trading Commission and the Consumer Finance Protection Bureau – to seek penalties in administrative proceedings
- The authority of the SEC to seek non-fraud-based penalties in administrative proceedings, such as penalties for books-and-records violations or officer and director bars.
Welcome news for defendants
The court’s decision in Jarkesy is welcome news for entities and individuals subject to SEC enforcement actions. It likely enhances defendants’ leverage in negotiating resolutions with the SEC by ensuring the agency’s enforcement actions seeking fraud-based penalties will be tried in a neutral forum, with robust procedural protections and before a jury. The full effect of the decision remains to be seen, however, as other litigants are likely to challenge the ability of federal agencies to seek remedies in administrative proceedings.
Brad Bondi is global co-chair of the investigations and white-collar defense practice at Paul Hastings. Michael Wheatley is of counsel in the group. The authors would like to thank Traci Zeller, who tragically and unexpectedly passed away in August, for her contributions to this article