While most of the U.S. was still trying to process a leaked Supreme Court decision that would invalidate Roe v. Wade, another legal ruling dropped last week that some experts say would effectively make it impossible for the country's top financial regulator to do its job.
In Jarkesy v. Securities and Exchange Commission, the 5th U.S. Circuit Court of Appeals ruled that the SEC violated the U.S. Constitution by seeking civil penalties for the defendants, hedge fund founder George Jarkesy and his firm, which included barring Jarkesy from the securities industry without trying him in federal court.
The ruling was a shock to many legal experts, because what the SEC was attempting is fairly common. Regulatory agencies often adjudicate cases administratively (i.e. not through the court system) when there is a clear violation of the statutes under their purview.
Notably, agencies only do this for civil cases. Criminal case must be tried in court. Where it gets complicated is when there is a civil penalty, which usually involves a fine or some other kind of punishment short of locking someone up (like losing a professional license).
In this case, the agency pursued an administrative legal action against Jarkesy's two hedge funds for multiple charges of fraud. The defendants then petitioned for the case to be moved into district court, which kicked off the process that led to last week's controversial ruling.
Why This Could Be a Big Deal
Why is this a big deal? According to critics, it's like throwing a wrench into the entire administrative state. If this ruling becomes the law of the land, they argue, every single enforcement action would have to be processed through the court system, putting a massive new burden on both regulators and the current legal system.
"As a practical matter, it would be impossible for the federal court system to process all of these cases on its own without exponentially expanding the federal bench and probably also loosening rules of evidence and procedure in federal court," wrote Blake Emerson, assistant professor at the UCLA School of Law, in an opinion piece for Slate.
He added that the administrative court system is better geared toward addressing issues in their respective areas of expertise. The SEC, for example, is arguably better equipped to handle complex securities cases, while the Environmental Protection Agency is better suited to handle cases involving complicated, often science-based environmental regulations.
If you put all of these cases through the court system, critics say, and suddenly you have judges and juries without that crucial background knowledge weighing in on cases.
For those celebrating the 5th Circuit decision, this return to more conventional due process is a good thing.
"All of this is a blow to the SEC, but it’s a blessing for the proper understanding of the Constitution," wrote The Wall Street Journal Editorial Board. "The agency isn’t used to losing cases since defendants often settle to avoid the expense and hassle of litigation."
The SEC brought 208 administrative enforcement actions in 2021, compared to 226 cases that it filed in the federal court system. So it's roughly a 50-50 split, which means the SEC could soon find itself in court much more frequently.
Why This May Be No Big Deal
Thomas Gorman, a partner at Dorsey & Whitney LLP and a former SEC attorney, is in the camp that thinks this isn't necessarily a problem.
"From the agency's point of view, it's simpler if they can do administrative proceedings," he said. "But that doesn't necessarily mean you're getting a better proceeding."
He explained that actual trials involve a lot more evidence discovery and fact-finding and that they also require lawyers to really learn their stuff so that they can present the case to a jury.
John Reed Stark, a legal consultant who spent 15 years as an SEC enforcement attorney, is less convinced that this ruling will significantly hurt the agency's ability to regulate.
"What's so great about administrative courts? What's the big deal? It's just like preparing a case for litigation. You prepare the same way. Sometimes it's easier, because the rules of evidence don't apply, but it's not so much easier that you'd need more staff."
He also said that more due process is a good thing for the integrity of the process.
"I've never been a big fan of bringing cases in administrative proceedings for lots of different reasons," he said. "I think serious cases are always meant to be in federal court."
As many learned from the recent leaked Supreme Court decision, however, the legal system is hardly neutral territory, and more cases tried in federal courts could mean more opportunities for judges of different political stripes to weigh in on enforcement actions.
On the flip side, the same is true of regulatory agencies, which are also shaped by political appointments.
Whatever the ultimate social value of the 5th Circuit ruling, Gorman admitted that it will likely make the SEC's jobs harder.
"It will take more time. It will take more resources. They probably won't like it, and they'll probably lose more cases."
