Overview
On May 18, 2022, a Fifth Circuit panel agreed (2-1) with petitioners in Jarkesy et al. v. U.S. Securities and Exchange Commission, No. 20-61007, that the Securities and Exchange Commission’s (SEC) enforcement proceedings suffered from constitutional defects. Specifically, the panel ruled that (i) petitioners were deprived of their constitutional right to a jury trial; (ii) Congress unconstitutionally delegated legislative power to the SEC by failing to provide it with an intelligible principle by which to exercise the delegated power; and (iii) statutory removal restrictions on SEC Administrative Law Judges (ALJs) violate Article II.1
The appeal arose from an enforcement action brought against petitioners Jarkesy and Patriot28 alleging securities fraud.2 Jarkesy had established two hedge funds and selected Patriot28 as the investment advisor.3 The funds brought in over 100 investors and held about $24 million in assets4. After launching an investigation in 2011, the SEC brought an enforcement action within the agency (as opposed to in federal district court).5 Petitioners unsuccessfully sought to enjoin the enforcement proceeding on the grounds that it was unconstitutional.6 The case proceeded within the agency and an ALJ concluded that petitioners committed various forms of securities fraud.7 The Commission affirmed and ordered civil penalties, disgorgement, and that petitioners cease and desist from further violations.8
We discuss herein the unexpected ruling and the potential implications for the Federal Energy Regulatory Commission ("ERC").
The Fifth Circuit Panel's Ruling
1. Deprivation of Constitutional Right to a Jury Trial
Central to its ruling that petitioners were deprived of their Seventh Amendment right to a jury trial was the panel's finding that "the SEC's enforcement action is akin to traditional actions at law to which the jury‑trial right attaches."9 After reiterating the importance of a trial by jury to our legal system, the panel explained that the right attaches to "suits in common law" that the Supreme Court has interpreted to include "all actions akin to those brought at common law as those actions that were understood at the time of the Seventh Amendment's adoption."10 The Supreme Court has specifically held that the Seventh Amendment right to a jury applies to suits brought under a statute seeking civil penalties.11
While the ruling recognized that Congress may properly assign an action that centers on "public rights" to administrative adjudication,12this was not one of those cases because fraud prosecutions were regularly brought in English courts at common law.13 The fact that other elements of the SEC's enforcement proceeding were more equitable in nature did not invalidate the jury-trial right that attached.14 Further, jury trials would not "dismantle the statutory scheme" nor are securities fraud enforcement actions the sort that are uniquely situated for agency adjudication.15 The decision forcefully rejected the notion that "Congress can convert any sort of action into a 'public right' simply by finding a public purpose for it and codifying it in federal statutory law."16 It also described the idea that "[w]hen the federal government sues, no jury is required" as "perhaps a runner-up in the competition for the Nine Most Terrifying Words in the English Language."17
2. Unconstitutional Delegation of Legislative Power to the SEC
The decision next addressed petitioners' argument that the SEC's unfettered authority to choose whether to bring enforcement actions in Article III courts or within the agency is unconstitutional.18 "Because Congress gave the SEC a significant legislative power by failing to provide it with an intelligible principle to guide its use of the delegated power," the majority agreed that there has been an unconstitutional delegation of power.19 The SEC was not "merely exercis[ing] a form of prosecutorial discretion."20 Instead, it effectively gave the SEC the power to decide which defendants should receive certain legal processes and which should not.21 And after giving the SEC that power, it failed to provide the agency with an intelligible principle by which to exercise it, as is required under Supreme Court precedent.22 While recognizing that the Supreme Court has not in the past several decades held that Congress has failed to provide the requisite intelligible principle, the panel said that the Court has not been confronted with the issue when Congress has given no guidance whatsoever.23
3. Unconstitutionality of Statutory Removal Restrictions for SEC ALJ's
The decision also identified a third constitutional defect with the SEC's enforcement proceedings: the statutory removal restrictions for SEC ALJs violated Article II.24 Pursuant to Article II, the President must "take care that the laws be faithfully executed."25 To do so, the President must have a certain degree of control over executive officers.26 SEC ALJs are inferior officers who can only be removed by the SEC Commissioners if good cause is found by the Merits Systems Protection Board.27 In turn, SEC Commissioners and MSPB board members can only be removed by the President for cause.28 The panel found that this amounted to SEC ALJs being protected by "at least two layers of for-cause protection from removal," which is unconstitutional.29
Given the significance of the ruling, the SEC is likely considering an appeal.
Implications from the Fifth Circuit Panel's Ruling
While the Fifth Circuit panel’s ruling applies to SEC enforcement proceedings, parties will undoubtedly seek to apply it to enforcement proceedings of other agencies, including FERC. Indeed, the decision was raised by parties challenging a FERC ALJ proceeding within days of the decision.
On May 20, 2022, plaintiffs Rover Pipeline, LLC and Energy Transfer LP filed a supplemental brief in support of a stay of FERC ALJ proceedings in light of the Jarkesy decision.30 Rover and Energy Transfer argued, inter alia, that the Fifth Circuit panel's ruling and the Supreme Court's recent grant of certiorari in Securities and Exchange Commission, et al. v. Cochran31 support that "the ongoing FERC proceeding violates Article II because FERC ALJs, like SEC ALJs, enjoy unconstitutional protection from removal; and violates the Seventh Amendment, which guarantees a jury trial for the type of violation alleged here" (e.g., the imposition of civil penalties for alleged violations of the Natural Gas Act in connection with Rover's construction of a natural gas pipeline).32 At a hearing on May 20, defendants did not oppose plaintiff's motion for a stay and on May 24 the district court entered an order staying both the district court proceeding and the underlying FERC proceeding.33
More broadly, Fifth Circuit's decision calls into question the constitutionality of aspects of FERC's enforcement process and use of ALJs. A critical question in light of the Fifth Circuit panel's decision will be whether the subject of an enforcement action has the option to go to federal court or must proceed before an ALJ. Under the Natural Gas Act, enforcement cases can only be adjudicated by an ALJ.34 This is in contrast to the Federal Power Act, which gives subjects the option to proceed before an ALJ or go directly to federal court.35 Another key issue will be whether the action is "akin to traditional actions at law to which the jury‑trial right attaches" or is "uniquely situated for agency adjudication."36 Enforcement actions alleging market manipulation seem analogous to the securities fraud cases that the Fifth Circuit panel considered in Jarkesy, while electric, oil, and gas rate cases seem less likely to be impacted by the ruling. An open question remains as to whether and how Jarkesy will apply to other enforcement matters that implicate civil penalty authority.
Endnotes
1Jarkesy v. Securities and Exchange Commission, 2022 WL 1563613, at *13 (C.A.5, 2022).
2Id. at *1.
3 Id.
4 Id.
5Id.
6Id. (referencing Jarkesy v. United States Securities and Exchange Commission, 48 F.Supp.3d 32, 40 (D.D.C., 2014), aff'd, 803 F.3d 9, 12 (D.C. Cir. 2015)).
7Id.
8 Id. at *2.
9Id.
10Id. at *3 (quoting Tull v. United States, 481 U.S. 412, 417 (1987)).
11 Id. (citing Tull, 481 U.S. at 418-24).
12 Id. (citing Atlas Roofing Co., Inc. v. Occupational Safety and Health Review Com’n, 430 U.S. 442, 450 (1977)).
13 Id. at *4.
14Id. at *5.
15Id.
16 Id. at *6 (citing Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 61 (1989)).
17Id. (quoting Ronald Reagan, Presidential News Conference (Aug. 12, 1986), https://www.presidency.ucsb.edu/documents/the-presidents-news-conference-957).
18See id. at *8.
19 Id.
20Id. at *10.
21 Id.
22Id.
23Id. (referencing Whitman v. Am. Trucking Ass'ns, Inc., 531 U.S. 457, 474–75 (2001); Panama Refining Co. v. Ryan, 293 U.S. 388, 405–06 (1935)).
24Id. at *11.
25Id. (quoting U.S. Const. art. II, § 3).
26 Id. (citing Myers v. United States, 272 U.S. 52, 117 (1926)).
27Id. at *12.
28 Id.
29 Id. (referencing Free Enterprise Fund v. Public Co. Accounting Oversight Bd., 561 U.S. 477, 498 (2010)).
30 Rover Pipeline, LLC v. FERC, No. 3:22-cv-00232, (N.D. Tex.) Pls.’ Supplemental Br. (Doc. 32) (May 19, 2022).
31Id. at 1 (referencing SEC v. Cochran, 2022 WL 1528373, at *1 (U.S., 2022)).
32Id.
33 Id., Order (Doc. 34) (May 24, 2022).
34See 15 U.S.C. § 717n.
35 See 16 U.S.C. § 823b.
36 See Jarkesy, 2022 WL 1563613, at *3, *5.
