The SEC’s Administrative Proceedings May Soon Disappear

On May 18, 2022, the Fifth Circuit ruled that the Securities and Exchange Commission’s (“SEC’s”) use of Administrative Law Judges (“ALJs”) to adjudicate SEC actions internally violates the United States Constitution. Specifically, the Circuit determined that the SEC’s administrative proceedings deny defendants their Seventh Amendment right to jury trials, that Congress violated the Constitution by delegating legislative power to the SEC without necessary guidance, and that removal restrictions on the ALJs violate the Take Care Clause of Article II of the Constitution.

Administrative proceedings, like those held before the SEC’s ALJs, are common among regulatory agencies and allow in-house judges to determine the outcome of enforcement proceedings without the need for an action in federal court. Use of administrative proceedings relies on the principle that when actions involve exclusively public rights – such as the public’s or market’s right to certain truthful information – a jury trial is not guaranteed. The Fifth Circuit’s opinion rejects that reasoning, holding instead that “The Seventh Amendment guarantees petitioners a jury trial because the S.E.C.’s enforcement action is akin to traditional actions at law to which the jury-trial right attaches.” In other words, the Circuit determined that SEC actions also involve certain non-public rights.

The decision is the latest chapter in a decades-long debate about the constitutionality of administrative proceedings. The 2010 enactment of the Dodd-Frank Act greatly expanded agencies’ powers to bring cases in front of their own judges. The reason for expanding those powers was based in large part on arguments from politicians, lawyers, and judges that administrative law judges, who have expertise in agency subject matter, are better suited to adjudicate complex securities law violations than are generalist federal judges. In the case of the SEC, Dodd-Frank also expanded the scope of potential defendants beyond persons and entities directly regulated by the SEC and enhanced the remedies (including penalties) that would be available against any defendant in an administrative tribunal, all of which provoked an outcry from across the bar that rights guaranteed in judicial proceedings in federal court were being denied. Since Dodd-Frank’s enactment, politicians have been fighting over the constitutionality of administrative proceedings and legal studies have attempted to determine whether defendants have a greater chance of success in administrative or court proceedings (interpretations remain unsettled). 

The Fifth Circuit’s ruling ends SEC’s ability to rely on administrative proceedings solely in matters that would fall within the Circuit’s jurisdiction (including Texas, Louisiana, and Mississippi). That does not mean the ruling necessarily will be limited for long. Indeed, on May 16, 2022, two days before the Fifth Circuit decision was published, the Supreme Court agreed to look at a narrower case involving the constitutionality of the SEC’s ALJs. That case – also arising out of the Fifth Circuit– queries whether a defendant charged in an SEC in-house action can bring constitutional challenges to the SEC’s proceeding in federal court before completing the SEC’s in-house appeal process, as is currently required. In 2021, a majority of the Fifth Circuit sitting en banc ruled that federal securities laws do not divest federal courts of jurisdiction to hear constitutional challenges to ALJ proceedings, even at early stages of the actions. The ruling created a circuit split, and the Supreme Court granted cert.

What does this mean about the future of administrative actions? For the first time in many years, the Supreme Court may have to opine on the constitutionality of ALJ proceedings and the scope of matters that properly may be brought before in-house judges. And while the Court granted cert on a case involving the SEC, the application of the Court’s ruling will not be limited to that agency. In short, the Court could substantially alter the legal landscape for agency actions at the SEC and every other administrative agency.