The Fifth Circuit Strikes a Blow to the Constitutionality of SEC Administrative Proceedings

23 May 2022 Foley Funds Legal Focus Blog
Author(s): Thomas J. Krysa Stuart E. Fross Brooke D. Clarkson Adrian L. Jensen Margaret Gembala Nelson Kathryn Marie Throo

On Wednesday, in a 2-1 decision, a three-judge panel of the U.S. Court of Appeals for the Fifth Circuit ruled in Jarkesy v. SEC that proceedings before an SEC administrative law judge were unconstitutional. Notably, the circuit court found the underlying proceedings unconstitutional primarily due to the lack of a jury trial when the SEC is seeking civil penalties in a fraud action. In the decision’s opening paragraph, which sets the stage for the ruling to follow, the circuit court commented that the SEC often acts as both “prosecutor and judge, and its decisions have broad consequences for personal liberty and property.” The Constitution, however, “constrains the SEC’s powers by protecting individual rights” and “[t]his case is about the nature and extent of those constraints in securities fraud cases in which the SEC seeks penalties.” The circuit court decision is the latest in a series of challenges to the SEC’s administrative authority and is likely to further chill the SEC’s use of administrative proceedings for litigated actions.


George Jarkesy established two hedge funds that raised about $24 million from more than 100 investors. The SEC brought an administrative action against him and his adviser entity, Patriot28, for fraud under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Advisers Act of 1940 alleging misrepresentations regarding the funds’ prime broker and auditor, the funds’ investment parameters and safeguards, and the value of the funds’ assets. Initially Jarkesy and Patriot28 sued the SEC in the U.S. District Court for the District of Columbia and attempted to enjoin the SEC administrative proceeding on constitutional grounds. The injunctive proceeding was unsuccessful1, and Jarkesy and Patriot28 ultimately were found liable by the SEC’s ALJ. Petitioners appealed to the Commission, which affirmed the ALJ’s decision and ordered petitioners to disgorge $685,000, pay a civil penalty of $300,000, and which barred Jarkesy from securities industry activities. Petitioners raised several constitutional arguments both before the ALJ and to the Commission, including that the ALJ was biased against petitioners, that the Commission inappropriately prejudged the case, that the Commission did not use constitutionally delegated legislative power when it decided to pursue the case in its administrative forum and the proceeding violated petitioners’ equal protection rights, that the removal restrictions for SEC ALJ’s violated Article II and separation-of-powers principles, and that the proceedings violated petitioners’ Seventh Amendment right to a jury trial.

On appeal, the circuit court focused on three constitutional arguments holding that: (1) petitioners were deprived of their constitutional right to a jury trial, (2) Congress unconstitutionally delegated legislative power to the SEC by failing to provide intelligible principles to exercise such power, and (3) the statutory removal restrictions of SEC ALJ’s violated Article II of the Constitution. The circuit court vacated the SEC decision and remanded the case for further proceedings.

In its decision, the circuit court spent considerable time analyzing the constitutional right to a jury trial. The court highlighted that civil juries are an important check to government power citing Thomas Jefferson and the Federalist Papers. The court was not persuaded by the SEC’s argument that the legal interests at issue vindicated distinctly public rights; instead, the court found the rights that the SEC sought to vindicate arise “at common law” and therefore are protected under the Seventh Amendment when the SEC seeks civil penalties in a fraud action.

The court went on to conclude that Congress had unconstitutionally delegated legislative power to the SEC, to seek civil penalties in the administrative forum because the choice to proceed in front of an ALJ or before an Article III judge is in the SEC’s absolute discretion and lacked any “intelligible principle” by which the SEC could exercise its delegated authority.2 The court also found the statutory removal restrictions violate Article II. According to the court, ALJ’s must be subject to removal at the direction of the president or senior officers that the president can readily remove. As ALJ’s currently enjoy “for cause” removal protection, as do SEC commissioners, the president’s authority to ensure that laws are faithfully executed is unconstitutionally restrained and, as a result, the statutory removal restrictions on ALJs are unconstitutional.3

Concluding Thoughts

This case is significant both in terms of substance and timing. The circuit court’s focus on petitioners’ right to a jury trial when the SEC seeks civil penalties in a fraud action directly addresses a longstanding complaint by respondents in SEC administrative proceedings. It will be interesting to see if this decision gains traction with other courts and/or with other administrative forums that often are compared to SEC administrative proceedings. This ruling also comes only two days after the U.S. Supreme Court agreed to hear an appeal of a Fifth Circuit en banc decision involving Texas accountant Michelle Cochran, who is making similar constitutional challenges to the SEC’s administrative powers.


1 The district court, and later the U.S. Court of Appeals for the D.C. Circuit, found that because there was no final order, the district court had no jurisdiction.

2 In a footnote, the court explained that this was an alternative holding that provides grounds for vacating the SEC’s decision.

3 The court explained that because it was vacating the SEC’s judgment on other grounds, it did not need to decide if vacating would be the appropriate remedy based on this issue alone.

This blog is made available by Foley & Lardner LLP (“Foley” or “the Firm”) for informational purposes only. It is not meant to convey the Firm’s legal position on behalf of any client, nor is it intended to convey specific legal advice. Any opinions expressed in this article do not necessarily reflect the views of Foley & Lardner LLP, its partners, or its clients. Accordingly, do not act upon this information without seeking counsel from a licensed attorney. This blog is not intended to create, and receipt of it does not constitute, an attorney-client relationship. Communicating with Foley through this website by email, blog post, or otherwise, does not create an attorney-client relationship for any legal matter. Therefore, any communication or material you transmit to Foley through this blog, whether by email, blog post or any other manner, will not be treated as confidential or proprietary. The information on this blog is published “AS IS” and is not guaranteed to be complete, accurate, and or up-to-date. Foley makes no representations or warranties of any kind, express or implied, as to the operation or content of the site. Foley expressly disclaims all other guarantees, warranties, conditions and representations of any kind, either express or implied, whether arising under any statute, law, commercial use or otherwise, including implied warranties of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Foley or any of its partners, officers, employees, agents or affiliates be liable, directly or indirectly, under any theory of law (contract, tort, negligence or otherwise), to you or anyone else, for any claims, losses or damages, direct, indirect special, incidental, punitive or consequential, resulting from or occasioned by the creation, use of or reliance on this site (including information and other content) or any third party websites or the information, resources or material accessed through any such websites. In some jurisdictions, the contents of this blog may be considered Attorney Advertising. If applicable, please note that prior results do not guarantee a similar outcome. Photographs are for dramatization purposes only and may include models. Likenesses do not necessarily imply current client, partnership or employee status.

Related Services