The U.S. Court of Appeals for the Fifth Circuit has declined a request by the U.S. Securities and Exchange Commission to reconsider a panel’s decision that determined the agency’s use of in-house courts to bring a securities fraud case against a hedge fund manager was unconstitutional.
Ten judges voted against rehearing, while six judges voted in favor and issued substantial dissent in which they stated that “…[b]eyond its massive impacts on the directly involved statutes, the opinion’s potential application to agency adjudication more broadly raises questions of exceptional importance…” that demands rehearing by the full court.
The SEC wished to convince the full appellate court to undo a May decision in which a three-judge Fifth Circuit panel ruled, in a 2-1 decision, that George R. Jarkesy Jr. and his advisory firm Patriot28 LLC, had been deprived of their constitutional right to a jury trial because the SEC pursued its fraud case in an administrative proceeding rather than in federal court. The panel decision released Jarkesy and Patriot28 from a nearly $1 million SEC judgment.
Jarkesy and Patriot28 sought review of the decision by an SEC administrative law court that they had purposefully made material misstatements and omissions to fund investors through marketing materials, financial statements, and monthly account statements.
The majority opinion of the three-judge panel that heard the appeal agreed with the challenge and held that the petitioners were deprived of their Seventh Amendment right to a jury trial.
The panel held that Congress unconstitutionally delegated legislative power to the SEC by failing to provide it with an “intelligible principle” by which to exercise delegated power. The Dodd-Frank Act allows the SEC to select whether it enforces securities laws in-house or in federal court, but fails to provide appropriate guidelines or guardrails, the absence of which the court has found impermissible.
The panel also held that the statutory removal restrictions on the SEC’s administrative law judges violated the constitution, as the ALJs appointed to oversee the agency’s in-house courts are unconstitutionally protected from removal. This issue has already been granted review by the Supreme Court during their current term in Cochran v. SEC.
The court’s rejection of the SEC request could have far-reaching implications in regards to the use of administrative law judges throughout the federal bureaucracy. More than 30 administrative agencies currently rely on ALJs, and the U.S. Supreme Court has granted certiorari to Axon Enterprise Inc. v. Federal Trade Commission and the Cochran case during the 2022-2023 term.
The SEC is likely to seek Supreme Court review of the Fifth Circuit’s decision in the Jarkesy case.