Commentary

The Jarkesy decision’s practical effects on agencies employing administrative law judges

The federal government's use of ALJs in general, and specifically at the SEC, has been repeatedly challenged as unconstitutional.

Ferdose al-Taie, Mya Green

August 14, 2024 3:17 pm

6 min read

Igniting the anticipation of securities and Constitutional law geeks everywhere, in Securities and Exchange Commission v. Jarkesy, the Supreme Court will finally adjudicate the constitutional issues raised by the SEC’s unilateral ability to forego a lawsuit in federal court and instead pursue enforcement actions — including monetary penalties — before the SEC’s own administrative law judges (ALJs) when the SEC alleges any violation of any federal securities law. The federal government’s use of ALJs in general, and specifically at the SEC, has been repeatedly challenged as unconstitutional because the administrative forum, unlike federal court, does not allow defendants the right to a jury trial — a right otherwise guaranteed by the Seventh Amendment. These simmering issues have now come squarely before the Supreme Court as a result of the SEC’s long-running prosecution of George Jarkesy, an enforcement action the SEC first filed in early 2013.

On appeal from the Fifth Circuit, Jarkesy brings three questions to the Supreme Court: (1) whether federal laws allowing the SEC to administratively adjudicate enforcement actions seeking civil monetary penalties violate the Seventh Amendment right to a jury trial; (2) whether federal laws allowing the SEC to choose to enforce the securities laws through an agency adjudication violate the nondelegation doctrine; and (3) whether federal laws granting for-cause removal protection to ALJs in federal agencies whose heads enjoy for-cause removal protection violate the “Take Care” clause of Article II of the Constitution.

The Jarskey facts are not unique; they follow countless other SEC Division of Enforcement administrative actions, which makes the Supreme Court’s rulings on the issues posed in this case likely to be widely applicable. In 2013, the SEC brought a cease-and-desist proceeding before one of its ALJs against numerous defendants, which included George Jarkesy and his investment adviser, Patriot28 LLC. The SEC alleged that Mr. Jarkesy and Patriot28 violated the antifraud provisions of the Securities Act of 1933, the Securities and Exchange Act of 1934, and the Investment Advisers Act of 1940. The ALJ held administrative proceedings and agreed with the SEC’s allegations. The ALJ ruled that Mr. Jarkesy and Patriot28 violated the federal securities laws, ordered them to cease and desist from further violations, and ordered them to jointly and severally pay a penalty of $300,000. Patriot 28 was ordered to pay disgorgement and prejudgment interest of about $1,000,000. Mr. Jarkesy was further penalized with a lifetime ban from the securities industry.

Mr. Jarkesy appealed, and the Fifth Circuit found in his favor on all fronts. First, it ruled that Mr. Jarkesy was deprived of his Seventh Amendment right to a jury trial on the fraud claims, which were the basis of the monetary penalty. Second, the Fifth Circuit ruled that the for-cause removal protection for ALJs violated the “Take Care” clause of Article II. Finally, the court characterized the SEC’s ability to elect to enforce the securities laws either in federal court or by administrative proceedings as a delegation of legislative power. The Fifth Circuit found that this delegation of legislative power is unconstitutional because Congress failed to provide an intelligible principle for allowing the SEC to unilaterally decide which forum to choose for its enforcement actions.

The issues in Jarkesy go to fundamental issues about the separation and delegation of power. The Constitution’s assignment of all legislative power to Congress bars Congress from delegating powers that are strictly and exclusively legislative to another branch. See Gundy v. U.S., 588 U.S. 128, 135 (2019). Congress may, however, “obtain the assistance of its coordinate Branches — and in particular, may confer substantial discretion on executive agencies to implement and enforce the laws.” The Supreme Court has held that a statutory delegation is constitutional if Congress “lay[s] down by legislative act an intelligible principle to which the person or body [authorized to exercise the delegated authority] is directed to conform.”

Congress’s power to make statutory delegations hangs in the balance as we await the Supreme Court’s ruling in Jarkesy. Congress has historically allowed some federal agencies to bring actions and seek penalties in either an administrative proceeding or federal court. If the Supreme Court determines that giving an agency the unilateral power to choose its forum is, in fact, a nondelegable legislative act, agencies that employ ALJs nationwide could see this freedom of choice significantly diminished.

More specifically, if the Court holds that the transfer of power violates the nondelegation doctrine,

the ripple effects could be substantial. For instance, Congress could repeal an agency’s ability to choose which forum to use to seek penalties or could create a new test for determining the appropriate forum that would address the equitable and constitutional concerns. This could eliminate or restrict an agency’s choice of forum and could force agencies to seek remedies before Article III federal judges instead of ALJs employed by those same agencies. In all likelihood, such a change would significantly decrease the number of proceedings presided over by ALJs. Consequently, if agencies are participating in a smaller number of administrative proceedings, we would likely see a decrease in the number of ALJ positions available or even the elimination of ALJ positions in smaller, less-funded agencies.

In addition, a ruling invalidating for-cause removal protection for ALJs could also have wide-ranging, practical implications for agencies employing ALJs. The challenge in Jarkesy argues that, under Article II, the executive power is vested in the President, who must “take [c]are that the laws be faithfully executed.” The Supreme Court has held that the Constitution gives the President “authority to remove those who assist him in carrying out his duties.” There are two exceptions to the President’s unrestricted removal power: (1) Congress can create expert agencies led by a group of principal officers, who are removable by the President only for good cause; and (2) Congress could provide tenure protections to certain inferior officers with narrowly defined duties.

ALJs are federal government employees, like any other. They apply for a job position that defines their duties as administrative law judges, and although they are required to be lawyers, there is no requirement to have practiced law in the area they will adjudicate. ALJs receive training in the law they will adjudicate, but as civil servants, ALJs can only be removed for good cause as determined by the Merit Systems Protection Board. How the Supreme Court rules in Jarkesy will have broad applications to the nearly 30 federal agencies authorized to employ ALJs, the defendants forced to appear before them instead of federal district judges, and the approximately 2,000 ALJs who work as civil servants.

Ferdose al-Taie is a shareholder based in Texas, and a member of Baker Donelson’s Government Enforcement Investigations Group. A former Department of Justice prosecutor and senior counsel in the U.S. Securities and Exchange Commission Division of Enforcement, al-Taie focuses her practice on white collar criminal defense, internal investigations, antitrust/competition law, SEC enforcement, government investigations and corporate compliance.

Mya Green, an associate in the Charleston, South Carolina and Washington, D.C., offices of Baker Donelson, focuses her practice on commercial litigation, government investigations and antitrust matters.